Income-Driven Repayment plans, such as IBR, PAYE, and SAVE, allow borrowers to make payments based on what they can afford rather than what they owe. Borrowers on these plans may wonder what happens to their student loan payments if they receive a large gift or inheritance. Will it cause their monthly payments to increase?
The good news for most recipients of a gift or inheritance is that the extra money typically won’t cause an increase in their student loan payments. For those who fall under an exception, there is a workaround to keep payments manageable.
Inheriting money or assets after a loved one passes away can be a huge relief, especially when you have outstanding student loans. That inheritance could give you the chance to pay down your student loan balance or even pay it off entirely. But if your federal or private student loans are in default, you may be worried that the government or a debt collector could seize your inheritance to satisfy the debt.
In this comprehensive guide, we’ll explain how inheritances and student loans interact. We’ll go over
- Whether the government can garnish an inheritance for federal student loans
- If private student loans can take inheritance money
- Strategies to protect inheritance from student loans
- What to do if your loans are in default
Can the Federal Government Garnish an Inheritance for Student Loans?
If your federal student loans are in good standing, the government cannot touch your inheritance money. The Department of Education has certain administrative collection tools at its disposal, such as wage garnishment and offsets of tax refunds and Social Security benefits. But an inheritance does not fall under their authority.
However, there is an exception. If your federal student loans go into default meaning you are 270+ days behind on payments the government could potentially garnish your inheritance. Here’s how it works
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When federal loans default, they are sent to a collection agency contracted by the Dept. of Education. The agency will attempt to collect through calls, letters, wage garnishment, etc.
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If collection efforts fail, the government can file a student loan collections lawsuit against you. If they win in court, a judgment will be entered against you.
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A judgment gives the government much broader collection powers, including the ability to seize assets. At this point, if you receive an inheritance, those funds in your bank account could be taken.
Thankfully, federal student loan defaults have declined in recent years due to increased enrollment in income-driven repayment plans. These plans base your payment on your discretionary income and family size, making repayment more affordable. As long as you stay current on an income-driven plan, your inheritance will be protected.
Can Private Student Loans Take Your Inheritance?
Private student loans operate a bit differently. Most private lenders will work with borrowers who run into hardship and fall behind on payments. But if you go into default, private lenders are often quicker to pursue legal action than the federal government.
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When private loans default, the lender will attempt to collect internally for a period of time. If you cannot enter into a satisfactory repayment arrangement, the lender may charge-off your loan and/or sell it to a debt buyer.
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The debt buyer or lender can then sue you for the amount owed. If they obtain a court judgment against you, your assets are exposed, including any inheritance you receive.
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In some states, private lenders can even garnish accounts or place liens on property without a lawsuit. However, this is less common.
The takeaway is this: both federal and private student loans can potentially take your inheritance if your account goes into default and creditors pursue legal action. But this worst-case scenario can usually be avoided by communicating with your lender and getting on an affordable payment plan.
Strategies to Protect Your Inheritance from Student Loans
If you have federal or private student loans and expect to receive an inheritance someday, here are a few tips to shield it from creditors:
Keep Your Loans Current
As long as your student loans remain in good standing, an inheritance cannot be seized. Enroll in income-driven repayment if you’re struggling to afford payments on federal loans. For private loans, ask the lender about hardship programs or extended repayment terms.
Receive the Inheritance as Income
Inheritances are shielded when sitting in an account untouched. But once you withdraw funds, they can be taken if a judgment is in place. Consider leaving an inheritance in an account to generate interest income, which is protected from garnishment under federal law.
Place Funds in a Trust
A properly structured trust keeps assets protected from creditors. Consult an estate planning attorney about setting up an irrevocable trust to receive the inheritance payout. The trust distributes funds according to the arrangements you put in place.
Consider Life Insurance
If you own any life insurance policies, make sure the payout is enough to cover your remaining private student loan balance. Life insurance benefits are generally creditor-proof.
Know Your State’s Laws
The level of protection inheritance enjoys against creditors varies by state. Meet with a consumer rights attorney to understand your risks based on where you live.
What to Do If Your Student Loans Go Into Default
Despite your best efforts, your federal or private student loans may eventually default, putting your inheritance at risk. Here’s how to respond:
For Federal Loans:
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Contact the loan servicer immediately to discuss options, such as consolidation or rehabilitation.
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Enroll in an income-driven repayment plan to avoid future default.
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If your loans are with a collection agency, ask about settlement offers and payment arrangements.
For Private Loans:
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Reach out to the current creditor (lender, debt buyer, collection agency) to see if they offer any hardship assistance or affordable repayment programs.
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Get the payoff amount and see if you can borrow funds from a 401k or retirement account to pay off the balance.
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Consult a student loan lawyer about negotiating a settlement or filing bankruptcy as a last resort.
The most important thing is acting quickly when your loans default. The faster you can resolve the situation, the less likely an inheritance is to be exposed.
Receiving an inheritance when you have student loans can be a double-edged sword. On one hand, the funds provide relief and opportunity. On the other, they can attract creditors if debts fall behind. Now that you understand the risks, you can take proactive steps to protect family assets. With prudent planning, your inheritance will remain safe and offer you financial freedom.
What does an Inheritance have to do with Student Loans?
To see how this issue can play out, we turn to a recent email. One of our readers, Daphne, is concerned about her student loan payments going up due to an inheritance she is going to receive.
Daphne writes:
Dear Student Loan Sherpa,
Thank you so much for this amazingly helpful resource. I have spent hours scouring articles and forum questions, and although I have gleaned and confirmed valuable information, the topic of my question has not been directly addressed. I am on year 3 of a 25 year IBR plan. (15% discretionary income and 25 years to forgiveness). Currently, my payments are at zero as I have not been working due to illness.
If I were to either inherit or be gifted a large lump sum (larger than the total of the loans, which has grown to about 75k because of capitalized interest), how would that affect my payment plan for that year and ongoing? I have spoken to 5 different people, both at the Dept of Ed itself and my servicer Nelnet, who all said the same thing but could not direct me to where I could find the answer in writing. They said that since inheritance or gift is not considered income, it would not affect my repayment. I understand that if the lump sum is invested, the accrued income would then be considered income.
The Basics – IDR Calculations
One of the major benefits of income-driven repayment plans is that they make student loan payments more affordable. The Department of Education designed these plans so that borrowers could afford their monthly payments regardless of how much they owe. Daphne worries, quite reasonably, that a large inheritance or financial gift will cause an increase in her monthly payments.
Fortunately for Daphne, the government’s formula for calculating affordable payments is quite straightforward. It looks at your state of residence, how many people are in your family, and what you reported on your most recent tax return. Using this information, your loan servicer calculates your discretionary income, and sets your monthly payment based on that. To see this calculation in action, be sure to check out the Department of Education’s Loan Simulator.
Federal student loans in default will be sent for collection, wages garnished
FAQ
Can the government take my inheritance for student loans?
Can the government take your money for student loans?
The government can collect your debt by withholding money from the following sources of income: your income tax refund and other federal payments. your wages.
Does student loan debt get taken out of the assets passed on to heirs?
If a borrower dies, their federal student loans are discharged after the required proof of death is submitted. The borrower’s family is not responsible for repaying the loans. A parent PLUS loan is discharged if the parent dies or if the student on whose behalf a parent obtained the loan dies.
How do I protect my assets from student loans?
Put Your Assets in a Trust
A trust can protect your assets that are included in the trust from going to anyone who is not named in the trust, and those assets cannot be used to pay your creditors.