Debt is part of life, and most people carry around a significant amount, be it through credit cards, mortgages or other lines of credit. With so many of us relying on credit, it is no surprise that people often die with outstanding debts left unpaid.
In short, although debts are not passed on to your family, even to your spouse, they are not written off automatically either: your debts stay with your estate.
This means that your estate must pay off remaining debts – as well as due taxes – before any of your assets can be passed on to your beneficiaries. Neither will the executor of your Will, if applicable, be personally responsible for paying off your debts.
There are two main exceptions to this, the first being joint debts. If the deceased co-signed a loan with someone else, they will take over responsibility for the debt. The second exception is for certain student loans, which are generally forgiven upon either the death or permanent disability of the borrower.
How about income tax? What happens to the mortgage? What happens to credit card debts? How life insurance helps Debt-specific life insurance policies Mortgage life insurance Credit card insurance
How about income tax?
A deceased estate must submit a final income tax return and, as with outstanding debt, pay all taxes owed before any assets can be inherited. This is not the same as the inheritance tax which is levied on the net value of the estate.
What happens to the mortgage?
It is not uncommon for people to die before their mortgage is fully paid off. Fortunately, because a mortgage is secured by the home, there is an asset to help pay off the unpaid mortgage. The bad news is that without proper planning, this can mean selling the family home.
Assuming that your home was bought together with your spouse as ‘joint tenants’, if the surviving spouse cannot service the mortgage, they might have to sell the home to pay it off. Depending on the spouse’s situation, it might be possible to refinance the mortgage to make the payments more manageable, by extending the total life of the mortgage, for example.
If a single person dies with an unpaid mortgage, the estate will be required to pay off the mortgage before any asset can be inherited. There are a few ways to fund this, including selling the home or using a life insurance benefit (more on that below). In order to avoid the forced sale of your family home, it is essential to have a plan for your mortgage.
What happens to credit card debts?
As with other types of debt, no one will take over your personal credit card debts. There are situations, though, where your credit card debts can affect the finances of those you leave behind.
Just like a mortgage, if a person dies while still owing credit card debt, creditors (like banks) can claim the money they are owed from the deceased’s estate. If the claim is successful, creditors will be paid out by the estate before beneficiaries receive any inheritance. In short, while loved ones will not be obligated to pay off your credit card debt, the net inheritance you may have left behind for them will be reduced.
If you are currently struggling with significant credit card debt, you may want to have an open and honest discussion with your most trusted loved ones, particularly if you are currently preparing your Will and the details of your estate.
How life insurance helps
For most people, the solution to paying off debt when they die is having a good life insurance policy. Life insurance pays a tax-free benefit upon death which can be used to pay off debt, including credit cards, mortgages and taxes. This preserves your savings and assets for your loved ones to inherit.
There are many different life insurance policies available, and each type is tailored to suit a different kind of person – be sure to compare life insurance policies before you make a decision. Whatever type you choose, make sure that your death benefit is enough to cover several costs:
All outstanding debts
Your expected tax liabilities at death (e.g. capital gains)
Income replacement to support any dependents you have
Any amounts of money you planned to save (e.g. university tuition for your kids)
Once you have a life insurance policy in place, it is essential that you maintain it and pay the premiums. The last thing you want is claims being rejected for some reason.
Debt-specific life insurance policies
Some life insurance policies have been made to specifically cover outstanding debts. These products are worth understanding.
Mortgage life insurance: a life insurance policy you might be offered when applying for a mortgage. A mortgage life insurance is a policy taken out by your lender. If you die, the life insurance company will pay out the remaining mortgage to your lender and your estate will keep the home.
This seems convenient, but it is generally more expensive and less flexible than a stand-alone life insurance policy. It also doesn’t cover the cost of capital gains tax, whereas a stand-alone policy could. You are often better off arranging your own life insurance coverage instead of purchasing a mortgage life insurance.
Credit card insurance: many credit cards offer balance protection, an optional type of credit card insurance. Balance protection can help reduce the burden of card payments during a job loss and, in some cases, full debt relief in the event you die.
As with a mortgage life insurance, you can cover your credit card debt with a life insurance policy. In fact, you can use a single life insurance policy to cover all of your debts, which avoids having to maintain multiple policies.
The prospect of death is not a nice one to think about. However, your estate getting eaten away by outstanding debt is even worse. In order to preserve your estate in the event of your death, the best thing you can do is to plan ahead.
Start by making a plan to pay off your debt quickly. Then, arranging protection for your family in the form of a sturdy life insurance policy.
If you have not made a will, this is the perfect time to do so. It is never too early to plan for the unexpected, while protecting the people you love in the process.
Writing your Will is the very first step, and it’s an important one. But that’s not enough. In the digital age, the next step is to store your Will online. Otherwise, what happens if your person of confidence is not able to find your Will in a timely manner? liteWill is the only Will registration platform that is available globally and that provides the option to store your Will online. ‘A Will that is not online is like a Will that does not exist’.
This portion of the website is for information only. The statements and opinions are the expression of their author, not of liteWill, and have not been evaluated for accuracy, completeness or changes in the law. Information contained in this article is not a substitute for tax or legal advice.
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