What happens to debts when you die? Is your family responsible for paying them off? Rod Cunich explains what happens next.
If only our debts died with us … but they don’t. As with ghosts, they live on to haunt those we leave behind.
Generally speaking, creditors come before your beneficiaries. Your deceased estate must pay all your debts before a distribution can be made to beneficiaries. If that means selling assets to pay the debts, the executor must do so; even if it reduces the assets available for distribution to beneficiaries.
If there are insufficient assets available to satisfy all your debts, your deceased estate can be bankrupted in the same way an individual can be bankrupted.
There are some very important exceptions to this scenario. Some assets are sacrosanct and can’t be touched by creditors. Your beneficiaries will receive the benefit of these assets even if the deceased estate is bankrupt.
So what are these protected species of assets? They include:
• superannuation death benefit payments received by the estate
• proceeds of life insurance policies received by the estate
• the proceeds from a compensation claim which form part of the estate
If you or one of your beneficiaries is exposed to financial risk because of your/ their occupation, then the use of these protected assets can play an important role in your estate planning.
On the other hand, these same assets can be used to pay off debts when no other funds are available. Your will must authorise your executor to use protected assets to pay specific debts. A common example is to authorise your executor to use life insurance proceeds to pay off a home mortgage. Life insurance can be a very valuable asset in your estate if you have debts you wish to cover for the sake of your family.
Be wary of the dreaded personal guarantee. We often guarantee business debts or debts of family members – then forget about the
exposure. The business or family member pays the lender the home repayments, unless you die and the debt has not been discharged. Most guarantee documents allow the lender to call in the guaranteed amount upon the death of a guarantor … even if the borrower is
up-to-date with payments. A lender could serve a demand on your executor for payment, which puts at risk some or all of the gifts to beneficiaries. Again, this is an issue for planning.
Lastly, executors should act with extreme caution. If they distribute all the assets to beneficiaries before they pay all debts of the estate, then they may be personally liable for payment of the debts. Being the executor of a deceased estate is no easy task and carries with it a modicum of financial risk.
The information in this article should be considered general in nature and legal advice should be sought. This information has been provided by Rod Cunich, author of Understanding wills and estate planning. Rod can be contacted via his site Rodcunichlawyer.com, where you can learn much more, and also buy a copy of his book.