Last updated: 13/06/2023 | Estimated Reading Time: 13 minutes
Although death isn’t an easy topic to talk about, it’s important to understand what will happen to your loved ones when you’re no longer around. In particular, if you have a lot of outstanding debt, you need to be able to get your affairs in order to ensure that your family will be financially protected.
In this article, we’ll go through the key things you need to know about what happens to debt when you die. By learning about the importance of organising your finances, writing a will and getting life insurance to cover your debts, you can reduce the amount of stress your loved ones will be facing at an already difficult time.
In This Guide:
- Can You Inherit Debt?
- Does Your Debt Die With You?
- Can You Pay Your Debts With Life Insurance?
- Decreasing Term Life Insurance
- Are All Debts Treated Equally?
- Checklist For Managing a Deceased Individual’s Estate
- The Importance of Life Insurance
Can You Inherit Debt?
In the UK, close relatives (e.g. your spouse or children) do not inherit your personal debt after you pass away.
Instead, the deceased person’s debts will be paid from their estate, which includes their cash, assets, possessions and investments.
The executor of the will (or the administrator if there was no will) is responsible for paying the deceased’s debts through the estate as their personal representative, but they aren’t personally liable. However, there may be certain circumstances where the executor could become liable, such as if an unknown creditor makes a claim against the estate after the executor has paid other debts and divided the rest of the estate amongst the beneficiaries (more on this later). They could also become liable if they distribute the funds incorrectly, which is why hiring a solicitor may be wise with more complicated estates.
Am I Responsible for My Spouse’s Debt After Death?
Spouses or civil partners are often regarded as the closest relatives of a deceased person. In fact, if someone dies without a will, then intestacy rules will apply, meaning that the person’s spouse (if they have one) will inherit most or all of their estate by default.
However, this doesn’t mean that they’ll inherit any debt, unless they have a joint debt with their spouse. Joint debts could include a shared mortgage, joint loan or a joint bank account with an overdraft. These debts will become the sole responsibility of the surviving spouse.
Individual debt cannot pass along to a spouse. Therefore, if the deceased person has an overdraft on an account that’s only under their name, this debt will be paid by the estate, not the surviving spouse.
Does Your Debt Die With You?
Your family isn’t responsible for paying your debts, but they will still need to be paid following your death.
An executor pays debts through the deceased’s estate in a certain order. Higher-priority debt will come first, such as secured debts, council tax and income tax, and then all other debts (including unsecured debts) will be paid after. The beneficiaries named in the deceased person’s will can only receive their share of the estate once all debts have been paid.
Assets such as properties can be sold to cover outstanding debt. Even after this, it’s possible that the value of the estate will be insufficient to cover all the debts, and in this case, the estate will be declared insolvent and the lower-priority debt will be written off.
Can You Pay Your Debts With Life Insurance?
Having a life insurance policy can be a huge help when it comes to paying off your debts after your death. If you have a life insurance policy and die within the valid term, your beneficiaries will receive a lump sum of cash upon your death, which they can use to cover mortgage repayments, bills, funeral expenses and other general living costs.
Most of the time, the life insurance money will go to your named beneficiaries, but if no beneficiaries are named in the policy, this money will go straight to your estate instead. This means the cash will be automatically used to pay off your debt.
Decreasing Term Life Insurance
In the case of home ownership, the surviving partner can often struggle to keep up with mortgage payments following their partner’s death. Decreasing term life insurance is particularly popular for this scenario as it’s specifically designed to cover the rest of the mortgage after your death. This is because the payout decreases over time in line with the remaining value of your mortgage, until the payout eventually reaches zero once the mortgage is paid.
Whole Life Insurance
Unlike term life insurance, which only pays out if you die within the set term (i.e., 20 years), whole life insurance offers a guaranteed payout whenever you die. Although this type of policy is more expensive, it can offer you peace of mind as you know your family will definitely be financially stable after your death.
Life Insurance In Trust
If you don’t want your life insurance money to become part of your estate after your death, one option is to write your life insurance policy in trust. Writing a policy in trust means that it’ll be looked after by a group of appointed trustees until the money is paid to your beneficiaries after you pass away. Since the money technically isn’t yours when it’s in trust, it won’t become part of your estate and therefore won’t be claimed by any creditors.
Putting your life insurance in trust will also help you pay less inheritance tax. Currently, inheritance tax is charged at a rate of 40% on estates with a total value of £325,000 and above, so your insurance money could be taxed if it becomes part of this estate. Writing your life insurance in trust prevents the money from entering your estate, which means you won’t have to pay any inheritance tax on this cash.
Are All Debts Treated Equally?
Although all debts must be paid following someone’s death (as long as they don’t have an insolvent estate), there’s a particular order in which they should be paid. This ensures that the most important debts are taken care of if there isn’t enough money in the estate to cover everything.
Here’s a quick summary of the different types of debts and their level of importance:
Funeral Expenses and Administrative Costs
Before money is taken out of the deceased person’s estate to pay their outstanding debts, the executor or administrator is allowed to take out money to cover administration costs and funeral expenses.
However, the amount of money used needs to be ‘reasonable’ based on how much is in the estate. For example, you couldn’t take out a lot of money for the funeral if the estate is very small and the deceased person had a large amount of debt.
If you’re worried about being able to cover your own funeral expenses, a funeral plan could be a great option for you. With a funeral plan, you pay in instalments or pay a lump sum of cash to a funeral plan provider, who will then invest your money into an insurance policy to keep it safe. By paying for your funeral upfront and at today’s costs, you can protect yourself against future price rises and ensure that your entire funeral service is already taken care of, which will be one less thing for your family to worry about.
The most important debts to be covered are secured debts. These debts are secured against an asset, such as a house or car. A mortgage is a common example of a secured debt.
If the deceased person was the sole owner of the house, then they may have named a beneficiary in their will to inherit the house and therefore take over the mortgage repayments. However, if the deceased person has a lot of outstanding debts, the house could be sold to cover these costs as it is part of their estate before it is transferred to any beneficiaries.
With a joint mortgage, which is where two people both own the entire house as joint tenants, the ownership of the house will automatically be transferred to the surviving partner and won’t be part of the estate. This person is then liable for paying off the mortgage, unless the deceased person had a life insurance policy that can cover the cost.
However, if you’re tenants in common, which means that two or more people own a share of the property each, the deceased person’s share won’t automatically pass onto the surviving partner and will instead become part of the estate. The deceased person can assign their share of the property to a nominated beneficiary in their will, but if this share needs to be sold to cover a debt, this could force the property to be sold.
Once the secured debts are paid, the executor of the will must then pay priority debts. These include council tax, court fines, utility bills, income tax, national insurance and child maintenance.
The consequences of not paying these debts are more severe, which is why they are considered to be a higher priority. Once these debts are paid, the executor should ensure that all creditors are notified of the death and all future payments are stopped.
The executor of the will could end up being personally liable for the deceased’s debts if undisclosed debts aren’t discovered and the creditors make a claim after the estate has been divided amongst the beneficiaries. Even if the executor knew the deceased well, they could have hidden debts that they were unaware of.
To prevent this from happening, it’s a good idea to place a Deceased Estates Notice in The Gazette and a local newspaper. This gives unknown creditors a chance to come forward and make a claim on the estate before it’s shared amongst the beneficiaries. The executor should allow at least two months for this because they won’t be held responsible for undisclosed debts after this period.
As mentioned earlier, no one else will be personally responsible for the deceased’s debts after death unless they had any joint debts. For example, if someone had a joint mortgage, joint loan or joint bank account with the deceased, they will become automatically responsible for these debts.
The same applies if someone has provided a loan guarantee. The guarantor will be liable for this debt if the person dies.
If you have a joint debt with someone who has died, you need to ensure that their name is taken off all future bills. If you’re struggling to make these payments on your own, it’s important to reach out to the creditors, explain the situation and see if you can agree on a more manageable repayment plan.
Finally, once all other debts have been settled, the estate must pay debts that are unsecured and only related to the deceased person. These individual debts can include personal loans, credit card debt, overdrafts and money borrowed from friends and family members.
Since these unsecured debts are considered low priority, they’re paid last out of all the owed money. If there isn’t enough money in the estate to cover these final debts, this is called an insolvent estate and these unsecured, individual debts are written off.
Checklist For Managing a Deceased Individual’s Estate
Most people choose someone close to them to be their executor, such as a friend or family member. This is because they have a greater understanding of the deceased’s financial situation and can be trusted to handle their affairs.
However, managing someone’s estate while grieving can be extremely difficult, especially if you don’t have a lot of experience with handling legal matters. With this in mind, here’s a helpful checklist of what an executor needs to do when managing a dead person’s estate.
1) Register the death
Before anything can be done, the death needs to be registered officially. You will have five days to register the death at a register office and obtain a death certificate.
2) Discover if there’s a will
Close friends or family members of the deceased should know if they have a will or not. If there’s a will, it’ll be much easier to deal with the estate as one or more executors will be named and the deceased’s wishes will be made clear.
If there’s no will, a close relative can apply to become the administrator of the estate. Intestacy rules will apply to determine who inherits what.
3) Apply for probate
Depending on the circumstances, the executor or administrator may need to apply for probate to access the deceased’s estate. Probate is the legal right to deal with someone’s estate when they die.
4) Tell creditors the person has died
To prevent future payments from the deceased’s bank account, the executor needs to tell the deceased’s creditors that they have died. They may ask for proof of death.
After this, the executor will need to ask for the outstanding unpaid balance on the debts and remove the deceased’s name from any joint payments.
This process is a lot easier if the deceased has organised their finances before their death. Therefore, if you want to reduce the burden on your family when you die, it’s important to get your affairs in order and tell close relatives where they can find your documents.
5) Check if they had life insurance
Life insurance can make it much easier for someone’s friends and family to deal with financial matters following their death. The executor should check if they had a life insurance policy in place and make a claim if possible.
6) Pay all the debts
Next, the deceased’s unpaid debts should be settled in priority order, which is as follows:
- Secured debts
- Priority debts
- Unsecured debts
If there’s no money in the estate to pay debts, the estate is insolvent and the debts are written off.
7) Divide the estate according to the will
Finally, once all debts have been paid, the executor can divide the estate among the named beneficiaries in the will. The executor has a legal obligation to follow the instructions of the will unless they aren’t legally valid.
The Importance of Life Insurance
Many people wonder what happens to debt when you die, especially if they’re worried about potentially inheriting a deceased person’s debts or burdening their children with debt in the future. Luckily, however, your individual debts won’t be passed on.
This isn’t the case for joint debts such as mortgages. In fact, if you die and your family can’t keep up with mortgage repayments, they could lose their home.
This is one of the many reasons why getting life insurance is extremely important. By covering mortgage payments, funeral costs, bills and other living expenses, life insurance policies ensure that your family is financially protected if you pass away.
To learn more about life insurance, get in touch with us here at Money Expert today. We can help you compare life insurance quotes to find the right policy for you.