With student loan debt approaching $2 trillion, and the Biden administration considering various proposals regarding loan forgiveness, student loans have become a divisive national political issue. Tuition costs continue to rise, which has resulted in an increasing number of people taking out student loans to pay for higher education. However, most borrowers do not fully understand many aspects of the debt. For example, according to a 2019 survey conducted by Haven Life, a life insurance agency, 73% of student loan borrowers do not understand what would happen to their student loan debt if they died. As a caveat, it is not clear what the future holds for student loan debt, with the potential for forgiveness of certain loans on the horizon. Below, I will discuss what happens to student loan debt when the borrower passes away and what borrowers and estate planners need to know, as it stands today.
How student loans are handled following the death of the borrower depends on the type of loan. There are two types of student loans: federal and private. The most common are federal student loans, which are backed by the federal government. The U.S. Department of Education contracts with various servicers to handle federal student loans. The standard federal loan is taken out by the actual student. Another form of federal student loan is a Parent Plus loan. These loans are taken out by a parent, to cover their child’s tuition. Regardless of whether the loan is a standard or Parent Plus loan, they are both federally backed student loans.
Separate from federal student loans are loans from a private lender. Private loans include those that were initially taken out as federal loans but subsequently refinanced by the borrower through a private bank or lender to lower the interest rate (i.e., Sofi). As opposed to federal student loans, loans from a private lender are not backed by the federal government.
The answer as to what happens upon the death of a borrower is more straightforward with federal loans. For standard federal loans taken out by the student, should the borrower pass away then 100% of the loans are forgiven? Because these loans are backed by the federal government, the borrower’s estate would not need to repay the loan. In essence, the government pays the servicer the balance of the loan upon the death of the borrower.
Alternatively, with Parent Plus federal student loans – where a parent takes out the loan to pay for the child’s education – if the student/child passes away, the loan is forgiven even though the loan was technically taken out by the parent. Additionally, if the parent who took out the loan passes away, the loan is also forgiven. In effect, the loan would be forgiven if either the parent or the student dies. As an aside, there are possible tax implications when it comes to loan forgiveness. For example, if the student dies and the parent is still alive, while the loan is forgiven, the discharged debt may be treated as taxable income to the parent. In this scenario, while the debt is forgiven, the parent may be required to report the forgiven debt as income on their tax return. This, of course, is subject to change depending on future governmental action regarding loan forgiveness.
Private loans, on the other hand, are not so forgiving. In fact, the vast majority of private loans are not forgiven at death. These loans are treated as any other unsecured debt of the decedent (i.e., credit card debt, medical bills, etc.). If a borrower with private loan debt passes away, the lender would need to file a timely claim against the decedent’s probate estate for the unpaid balance. The debt would need to be paid from the estate before inheritance. In situations where there is a co-signer on a loan and the borrower dies, the lender can go after both the estate as well as the co-signer for the full amount of the unpaid balance. The debt is the co-signer’s problem as much as the borrower’s problem.
For estate planning practitioners, there are a few items to keep in mind when it comes to clients with student loan debt. For clients that have federal student loan debt, there is no need to do much as it relates to estate planning because, as discussed above, if the borrower dies then the loan is fully forgiven. However, for those with private loan debt and either a co-signer or probate assets, the borrower should ensure there is a way to pay off that debt upon his or her death, such as sufficient life insurance or savings.
In situations where there is private loan debt with no co-signer, avoiding probate is extremely advantageous. For instance, even if the lender files a claim against a decedent’s probate estate, if there are no probate assets to administer and everything owned by the decedent passes outside of probate (via co-ownership, pay-on-death beneficiary designations, or through a Trust), the lender cannot come after those assets that pass outside of probate. While not getting into the ethics of going this route, the fact is that if assets are never in probate, then there is no probate money to pay the claim. As such, in that situation, the lender cannot force payment of the debt balance.
Zachary W. Worshtil is a Partner at the Law Office of Ralph W. Powers, Jr., P.C. He is also a member of the PGCBA Board of Directors and co-chair of the Probate, Estates, Trusts & Elder Law Section. He concentrates his practice primarily in estate administration, probate litigation and estate planning.