There are two certainties in life: death and taxes.But for most of us, there’s often another certainty: debt! Whether you have a mortgage, a credit card, a car loan, or a line of credit, debt is typically part of our financial mix
We get questions all the time about what happens when you die? Can you pass on debt? Who pays for your debt if you pass away? How does your executor or family deal with it when you’re gone.
Whether you’re wondering what happens to your own debt if you pass away or if you’re a beneficiary of someone who has debt, here’s everything you need to know about debts and estate planning.
What Happens If You Die With Debt?
We hate to be the bearer of bad news, but unfortunately, your debts don’t just disappear when you pass away.
When you die, your executor will take care of paying off your debts as part of the estate administration process. They will create an inventory of your assets, and an inventory of your debts/liabilities (loans, credit card balances, unpaid bills at time of death, taxes owing, etc.) and they will take care of paying off debts and closing accounts at that time.
There are few exceptions where your debt isn’t added to your estate:
- If you have jointly-held debts, they transfer to a surviving person (for example you have a car loan with your spouse - when you pass away, your spouse becomes the sole person on that loan)
- Typically the mortgage stays with the house. For example, Jane owns a home, and in her will she has left everything to her sister Sarah when she passes away. The home is valued at $500,000, and it has a mortgage of $200,000 remaining. When Jane passes away, Sarah can either elect to assume ownership of the house (and the mortgage would now be in her name), or she can elect to sell the home, pay off the mortgage, and keep the proceeds. The executor has the authority to sell or pass on an asset based on the circumstances, so they can work with a beneficiary to decide the best course of action
If the total value of debts and gifts exceeds the total value of the estate, the executor may not be able to satisfy all gifts as outlined in the will. In that case, the process of “abatement” takes place. In order to satisfy all debts, the value of gifts to beneficiaries may be reduced. To illustrate, here’s an example.
- Jason’s estate is valued at $400,000, and his debts (a mortgage, a car loan, and some credit cards) total $250,000. Jason has left $100,000 to each of his two siblings ($200,000 total), and the rest of his assets will go to his favourite charity. The total of the debt and those cash gifts totals $450,000, which is more than the value of the estate. In this case, his debts would be paid in full, and the remaining cash would be split 50/50 between Jason’s two siblings - they would receive $75,000 each, instead of the $100,000 he outlined in his will. Since there are no remaining assets, his favourite charity would not receive anything.
Do I Need A Will If I Have Debt?
“I don’t want to leave my debt to my family so I’m just not going to make a will.” We hear this all the time. It’s a common misconception that you should only make a will if you have lots of monetary assets. This is not true.
While a will helps distribute your assets when you pass away, it also provides instructions for other end-of-life wishes. In your will you will:
- Appoint an executor - the person who will wrap up your estate. If you don’t do this, the courts will have to appoint someone for you
- Assign a guardian for any minor children or pets - otherwise the courts will appoint one for you. Often this could not be the person you would have chosen yourself.
- Outline your funeral/burial wishes
- Pass on any heirlooms, sentimental items, or personal belongings to family or friends
Even if you don’t think your estate will have a lot of monetary value when you pass away, it’s still important to create a will. Think of your will like a blueprint for your family. Not only will it reduce the time your family has to spend wrapping up your estate, and it saves them from having any unanswered questions about your wishes.
Can My Beneficiaries Inherit My Debt?
We also often hear from individuals that they do not want a will, as they fear it means that they will pass their debt off to their beneficiaries. The good news is, that’s not quite how it works!
Your will does not distribute debts. If you have debt, it will be paid out of your estate. Here’s what happens if your estate cannot pay off your debts.
What If I Have More Debts Than Assets?
When you pass away there is an order of priority as to how things are paid. Funeral expenses typically come first. Afterwards, it will cover estate administration expenses (ie. hiring an accountant to help with the process). Once these expenses are covered, then debts will be paid. Once debts are accounted for, specific gifts will be paid out, followed by the residue (the pool of assets you divide up by percentage).
If your debts exceed your assets, your estate becomes insolvent - it cannot afford to pay off all the debts. Just like if you claim bankruptcy while alive, an insolvent estate means your creditors will not receive full payment
Debts are always paid in priority order (certain debtors have a legal right to payment first over others), and often partial debts will be paid (for example if debts total $150,000 and the estate is only valued at $100,000, a portion of debts owing will be paid).
If your residual estate is not enough to cover all debts, specific gifts will be reduced in order to satisfy those debts. This is a process called “abatement”
How Does My Executor Handle My Debts After I Pass Away?
When you make your will with Willful, we include a clause that gives your executor the power to settle debts and pay any taxes associated with the estate.
Your executor will:
- create a list of your debts/liabilities and confirm due the amounts and associated due dates
- close any accounts (for example notifying credit card companies that you have passed away so your account does not continue to accrue interest)
- advertise for credits (see more in the next section)
- pay any debts/liabilities (including filing your final tax return and paying any balances owing)
Typically your executor will find out about your debts and liabilities by reviewing bank records and credit card statements, personal papers, tax assessments, talking to family members, or reviewing email or physical mail. It is incredibly helpful to put together an list of your assets and your debts/liabilities and store it with your will so your executor doesn’t have to hunt this information down
How Do Creditors Know That I’ve Passed Away, And What Rights Do They Have To Collect On Debts?
When someone passes away, typically an executor will advertise for creditors to reduce their own liability. Your executor is essentially putting a notice out that you have passed away, and giving anyone you owe money to a period of time to make a claim. If they make a claim after that notice period, they may not be able to collect - the process varies by province.
This typically used to happen via an advertisement in the newspaper, but as we’ve moved to a more digital world the process has moved online. Today the most common way to advertise for creditors is NoticeConnect.
If your executor does not pay your debts, they can be liable to the creditors.
There are many nuances to advertising for creditors. If you are an executor and are looking for more details on the process, visit NoticeConnect’s website.
What If My Executor Doesn’t Know About A Debt That I Have?
If your executor doesn’t know about a debt, and they distribute assets to beneficiaries and wrap up the estate without paying that debt, the debtholder has a right to make a claim against the estate, and the executor can be held liable.
This is why the step of advertising for creditors is so crucial in the process of estate administration. This allows any liabilities you have that the executor may not know about to be brought to light.
In fact, the same is true for assets. There are millions of dollars sitting unclaimed in bank accounts belonging to dead people. Did you know that the government has to hold on to assets over $1,000 for 100 years? Only after that, do the assets go to the government?
You can avoid that by ensuring your executor knows about not just your debts, but your assets. Consider making a list of your assets and liabilities and store the list with your will - this ensures your executor won’t have to go on a wild goose chase to track down your debts or your assets