The short answer is: Bypassing probate with transfer-on-death (TOD)/payable-on-death (POD) designations and direct beneficiaries generally shields those assets from creditor claims, but it may leave the estate with no funds to pay legitimate debts like medical bills. Be aware that many states have statutes that explicitly allow for a creditor to seek assets conveyed to beneficiaries through nonprobate transfers if the estate is insolvent. Lastly, be aware of so-called ‘super creditors,’ i.e., federal and state authorities, secured creditors, child support or alimony obligatees, and others whose ability to seek repayment is unaffected by a nonprobate transfer.
That said, here is a breakdown of what often happens to the debt and the assets.
Nonprobate Assets Are Protected
When you use TOD for accounts or real estate, POD for bank accounts, and direct beneficiary designations for things like life insurance and retirement accounts (e.g., 401(k)s, IRAs), those assets are generally considered nonprobate assets.
- Bypass creditors: Because these assets pass directly to the named beneficiaries by contract or law, they typically do not become part of the probate estate. This means they are generally shielded from most of the deceased person’s unsecured creditors, such as hospitals, doctors, and credit card companies.
- Quick transfer: The beneficiaries get access to the assets quickly by presenting a death certificate to the financial institution.
How Medical Bills Should Be Paid
The person’s estate is legally responsible for paying their debts, including outstanding medical bills, before any money is distributed to heirs.
- The responsible payer: The medical provider will first make a claim against the estate of the deceased person.
- The problem: If you pass all your assets through TOD/POD designations, the formal estate (the assets that go through probate) will likely have little to no money (it will be “insolvent” or “asset-less”).
- Creditor options: Because the probate-avoiding assets are usually protected, the creditor (the medical provider) generally cannot force the beneficiaries to use their inherited money to pay the debt.
Will the Provider Write the Bill Off?
Yes, in most cases, if there is no money in the legal estate, the outstanding medical bills will likely go unpaid and may be written off by the provider or collection agency.
Creditors must collect from the estate. If the estate is empty, they have nowhere else to collect from, with a few important exceptions:
| Exception | What It Means |
|---|---|
| Spouse Liability | In community property states (like California, Texas, Arizona), a surviving spouse may be responsible for debts incurred during the marriage, including medical bills. State laws vary greatly here. |
| Medicaid Estate Recovery | If the deceased person received Medicaid benefits (usually age 55 or older), the state may have the right to try and recover the costs of care from all assets, including those transferred via TOD/POD. |
| Co-Signing | If a family member co-signed a medical agreement or financial guarantee (such as a nursing home admission contract), they are personally liable for that specific debt. |
| Fraudulent Transfer | If the assets were transferred with the specific intent to defraud creditors, a court could potentially reverse the transfer (though this is rare). |
While TOD and direct beneficiary designations are excellent tools for avoiding probate and protecting inherited assets, they can create a liquidity problem for the estate.
If you have significant potential debts (such as long-term care or medical bills), you must ensure there is a clear plan to cover them, or your creditors will simply go unpaid.
A common strategy is to designate the estate itself as the beneficiary of a portion of a life insurance policy, providing cash specifically to pay debts and final expenses.
Disclaimer: Estate planning and creditor rights are governed by state law, which varies significantly. You should always consult with a qualified estate planning attorney in your state to ensure your plan correctly handles debts and assets according to your goals.
Subscribe to the Knowledge Bank.
