Have you ever wondered what happens to a person’s debts when they die? Do their debts pass to surviving family members or are they completely extinguished? What if the person owed millions of dollars at the time of their death, being more than their assets? In this article, we look at the rules that apply when a person dies before paying off all their debts.

Generally speaking, when a person dies, their assets and liabilities will form part of their estate and pass to the person named as executor in their will once probate is granted.

However, before the executor distributes any assets to the beneficiaries who are named in the will, he or she must discharge the liabilities of the estate using whatever funds are available. The executor is authorised to realise both real and personal property to satisfy estate debts. They may also use the assets of the estate to pay for testamentary expenses, including funeral and administrative expenses.

Are secured and unsecured debts treated differently?

A secured debt is a debt that is fixed to one or more assets, such as a home loan that is secured against the borrower’s property, whilst an unsecured debt is not attached to any asset, for instance, a credit card debt. Secured debts will be discharged by the executor before unsecured debts.

If a beneficiary has been bequeathed an asset that was used to secure a debt, and the beneficiary wants to retain that asset, then, subject to any contrary intention expressed in the will or another document made prior to the testator’s death, the beneficiary must bear the burden of the debt that is attached to the asset. In other words, the beneficiary must repay or refinance the secured debt before the asset is transferred to them.

Unsecured debts held solely in the deceased's name will usually be paid from money held in the estate. If there is not enough money available to repay the debt, then property may need to be sold to help pay off debts. If there are not enough assets in the estate to meet all the estate debts, the executor may need to contact creditors to let them know that the debts cannot be repaid, and to ask for the debts to be 'written off'. However, creditors are not required to write off debts, and if the debt amounts to $5,000 or more (or an aggregate of debts owed to two or more creditors amounts $5,000 or more), the creditor/s may apply to court to have a bankruptcy trustee appointed to the estate. An executor can also apply to appoint a bankruptcy trustee if they conclude that the estate is insolvent (that is, unable to pay the debts and other liabilities of the estate in full).

In what order are assets used to discharge debts?

Once the beneficiaries have agreed to accept and deal with any charged assets that have been left to them, the executor will satisfy the remaining estate debts and obligations in accordance with the order prescribed by legislation, unless the will states otherwise.

In New South Wales, the Probate and Administration Act 1898 (NSW) (the Act) regulates this process. The Act expressly reserves the priority rights of mortgagees and other secured creditors. It also notes that all unsecured debts stand in equal degree. Schedule 3 of the Act stipulates the order in which assets should be applied to debts.

Where the estate is solvent, the first category of assets that should be used to discharge debts are assets that are not effectively disposed of by the will (this includes lapsed or void gifts), provided that the executor retains a fund from this category of assets that is sufficient to meet any pecuniary legacies left in the will. However, where the estate is insolvent, then the funeral, testamentary, and administration expenses have priority, and the remaining debts and liabilities will be governed by the laws of bankruptcy.

Are there any assets that cannot be used to discharge debts?

Unless the will provides otherwise, the deceased’s superannuation death benefits and life insurance benefits cannot be used to discharge any debts owed by the estate. The payments may be used, however, for the funeral, testamentary and administration expenses of the estate, and for the payment of legacies.

The assets of a unit or discretionary trust in respect of which the deceased was the trustee will not form part of the estate and are not available to the executor for payment of estate debts. This is because the assets are owned by the trustee (or successor trustee appointed in circumstances where the deceased was the trustee) in that capacity rather than in their personal capacity. Similarly, assets owned by a company that was controlled by the deceased will not form part of the estate. However, any units in a unit trust or shares in a company that were owned by the deceased will pass to the estate.

Finally, assets that are owned as joint tenants, such as bank accounts and real property, will not form part of the estate – they will pass to the remaining joint tenant/s (under the rule of survivorship).

Are there any debts that will pass to my family members?

Family members will only be held responsible for paying off estate debts if:

  1. the debt was secured against property owned by the family member;
  2. the debt was jointly incurred by the deceased and the family member (i.e. the family member was a co-borrower); or
  3. the family member personally guaranteed the deceased’s debt.

Accordingly, family members will not be held liable for satisfying the debts of a deceased family member, including a HECS/HELP debt or home loan, unless one of the above situations applies.

Take-home

  • If the estate has enough funds to pay off all estate debts, those debts will be paid, and the remainder of the estate will be distributed to the beneficiaries in accordance with the terms of the will.
  • However, if there are insufficient funds to pay off all estate debts (even after estate property is sold), then the debts will not be repaid, and creditors of the estate who are owed more than $5,000 may bankrupt the estate.
  • Family members of the deceased cannot be held liable for the deceased’s debts, unless one of the circumstances mentioned above apply.