Death & Student Loan Obligations

Not many years ago student loans and estate planning were rarely discussed in the same sentence. That is because in decades past far fewer individuals took out student loans and, even when they did, the size of the loans were smaller. Things are changing, however. Higher education is becoming more and more crucial to long-term employment and the cost of that education is increasing. These changes mean that more individuals have to take student loan obligations into account when conducting long-term financial planning. Those loans may the planner’s own loans or (even more likely) loans for children on which they co-signed.

In any event, more and more families have to take these issues into account in long-term planning. One issue on which there is much confusion is the discharge (or lack of discharge) of these obligations upon death.

Student Loan Obligations & Death
Forbes talked about a sad story this week on the potential long-term effect of loans, discharge, and taxes. The article shared the example of Roswell Friend–a student who committed suicide last year. The death wiped away over $55,000 in student loan debt that the student (and his mother) owed. However, while the debt obligation may be discharged upon death, that does not mean that there are not other financial complications–most notably involving taxes.

Cancellation of death income (“COD income”) is taxable. The idea is that forgiven debt is akin to income, because it is money that you received–a net financial benefit. Tax and legal professionals can explain some exceptions to avoid the tax bill in some of these cases. However, sometimes there are no other alternatives. That often includes forgiven student loan debt.

For example, in the case of Roswell Friend, her mother was hit with a $14,000 tax bill.
IRS pursuits of tax on forgiven debt is not uncommon. Many parents may be shocked to learn that they owe often significant tax bills on forgiven debt on which they co-signed.

The U.S. Department of Education, last year alone, cancelled more than $2.7 billion in loans as a result of bankruptcy, disability, or death. When parents co-signed on those loans, they may be on the hook for a significant tax bill.

Sometimes there are steps that can be taken to minimize a tax bill–at other times there are not. But no matter what, it is essentially for these issues to be taken into account when conducting long-term retirement and healthcare planning.

See Our Related Blog Posts:

Graduation Season is Perfect Time for Grandparents to Consider Gifts

Now Remains a Good Time for Baby Boomers to Conduct Estate Planning

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