By Teigan Hutchison
Summary:
What happens to debts when you die?
This article explores the treatment of different debts, such as HECS or education debts, outstanding tax owed to the Government, car debts, mortgages, and credit card debts, after an individual passes away.
Introduction:
Spoiler alert, the deceased’s beneficiaries will not automatically inherit the deceased’s debts.
When someone dies in Australia, their debts do not vanish. Instead, these debts become a part of their estate, which is then handled according to the deceased’s Will by the executor of the estate.
Is the estate solvent or insolvent?
The term ‘solvent’ means that the estate has sufficient assets to pay off any remaining debts, whereas ‘insolvent’ means that the estate has insufficient assets to pay off the deceased’s debts and liabilities. The solvency of the estate is a question of fact rather than one of legal interpretation.[1]
There are different processes for paying off the deceased’s debts depending on whether the estate is solvent or insolvent.
Where an estate is solvent, the executor must apply the assets as follows:
- Undisposed assets, subject to retaining sufficient funds to meet ‘pecuniary legacies’ (i.e., gifts of sums of money to people mentioned in the Will).
- Assets not specifically disposed of by the Will, subject to retaining sufficient funds to meet pecuniary legacies.
- Assets specifically disposed of by the Will for the payment of debts.
- Assets charged with or disposed of by the Will, subject to the charge for the payment of debts.
- The fund, if any is left, is retained to meet pecuniary legacies.
- Assets specifically disposed of by the Will according to their value.
Whereas, if an estate is insolvent, the executor follows different rules. The first priority is to pay off ‘funeral, testamentary, and administration expenses’. The second priority is to pay off outstanding tax debts and liabilities, secured debts like home or car loans, followed by unsecured debts.
However, insolvent deceased estates can also be administered under Federal law. The Bankruptcy Act 1966 (Cth) comes into play because either the person was insolvent when they died, or their deceased estate later became insolvent because of the debts accrued by the deceased estate’s legal personal representative. If bankruptcy proceedings had started before the person’s death, these proceedings will continue as if they were still alive.
Depending on the particular situation of the insolvent deceased estate, it may be more advantageous to administer the estate either under State or Commonwealth law.
Can you inherit the debts of an insolvent deceased estate?
Unless the debts are held jointly, or an individual has personally guaranteed payment of the deceased’s debt, the beneficiaries of a deceased estate do not inherit the deceased’s debts if the estate is insolvent.
Can Life Insurance or Superannuation be used to pay back the estate’s outstanding debts?
Life Insurance (also known as Death Cover):
Life insurance is safeguarded from being used to pay back the deceased estate’s debt. However, life insurance can still be utilised to pay back testamentary and funeral costs. If it was the deceased’s intention to make their life insurance policy available to pay back debts, they needed to either have an express agreement with their insurance provider, put down their life insurance proceeds as collateral for a debt repayment, or finally, expressly outline in their Will that life insurance proceeds could be used for debt repayments.
Superannuation:
Superannuation is not automatically dealt with as an asset of an estate unless the deceased nominated a beneficiary via a ‘binding death benefit nomination’ (BDBN) to receive payment from their super fund. As a result, the executor will usually not be able to use superannuation to pay off the estate’s liabilities.
However, if no beneficiary has been nominated, the superannuation fund trustee has the discretion over how to use the superannuation and will generally pay the monies into the estate for the executor to pay off liabilities and to distribute amongst the beneficiaries.
Two recent cases considered whether lump-sum death benefit payments were accessible to creditors if received under a bankrupt beneficiary.
In Morris v Morris [2016] FCA 846, a bankrupt widow received death benefit payments from her late husband’s superannuation funds, granted by the fund’s trustee’s discretion. The court ruled that the widow’s interest in the superannuation funds began when the trustees exercised their discretion in her favour. This satisfied section 116(2)(d)(iii)(A) of the Bankruptcy Act, exempting the property from creditor division.
In Cunningham v Gapes [2017] FCA 787, the bankrupt’s wife received money from her husband’s deceased mother’s estate because her husband did not have a bank account. The distribution from the deceased estate came from death benefit lump sum payments from the deceased mother’s superannuation fund. The court distinguished this latter case from Morris v Morris and ruled that the money did not represent an interest of the bankrupt in the superannuation fund. This case clarified that for Bankruptcy Act s 116(2) exemptions to apply, the super fund death benefit payments must come directly from the superannuation fund trustees to the bankrupt, without passing through the deceased estate. If the benefit passes to the deceased estate first, the benefit is typically considered divisible amongst creditors under s 116(1)(a) of the Bankruptcy Act.
Treatment of Debts:
Debts include all secured and unsecured loans that the deceased person had taken out, including:
- Car Debts
- Mortgages
- Credit Card Debts
- HECS-HELP or Education Debts
- Outstanding Tax Debt
Secured debts are those in which the loan has been provided on the basis that an asset is used as security for the loan. This means that if the lendee defaults, the lender has the right to take possession of the asset. Unsecured debts are those which are not attached to any assets.
Car Debts:
When it comes to car debts, the scenario can vary based on several factors. If the deceased owned the vehicle outright, the car would become a part of their estate and would be subject to distribution as per their Will or intestacy laws. However, if the vehicle was purchased using a car loan, the outstanding balance becomes a part of the deceased’s estate and needs to be addressed before transferring ownership to the beneficiary.
Mortgages:
Mortgages or home loans are typically secured debts, where the property itself serves as collateral. In the event of the borrower’s death, the mortgage does not disappear. Instead, the deceased’s estate is responsible for repaying the outstanding mortgage balance. If the estate lacks sufficient funds to cover the mortgage, the property may be sold to settle the debt.
Credit Card Debts:
Credit card debts after death can also be a matter of concern. Like other debts, the deceased’s credit card debt becomes a part of their estate. The executor or administrator of the estate is responsible for paying off the credit card debts using available estate funds. If the estate lacks the necessary funds, the credit card company may need to write off the debt.
Treatment of HECS-HELP or Education Debts:
HECS-HELP (Higher Education Contribution Scheme-Higher Education Loan Program) debts are a common financial obligation for many Australians who attended university, particularly in the years following a student’s transition into the workforce. The income threshold to start paying back HECS-HELP debt for FY2023-24 is $51,550.[2] Once you earn above this amount, compulsory repayments are made by your employer out of your salary. When you die, the executor of your estate will ensure, up to the date of your death, that all compulsory repayments have been paid. Whatever HECS-HELP debt remains is cancelled.[3] The same cancellation principle applies to all other HELP debts including FEE-HELP, OS-HELP, SA-HELP, STARTUP-HELP, and VET FEE-HELP.
Outstanding Tax Owed:
Thankfully, there are no death taxes in Australia. Nonetheless, any outstanding taxes will have to be paid from the deceased estate’s assets.
The personal legal representative of the deceased estate must file a tax return in cases where tax is withheld from their income. Contrarily, they have an obligation to pay taxes if the deceased earned above the minimum tax threshold ($18,200). Capital gains or losses are disregarded when you pass away.[4]
This article is not meant to act as legal advice and serves the purpose of providing academically generalised information regarding the general principles of Estate law. If you require qualified legal advice on anything mentioned in this article, our experienced team of solicitors at Foulsham & Geddes are here to help. Please get in touch with us on 02 9232 8033 today to make an enquiry.
[1] Re Pink; Elvin v Nightingale [1927] 1 Ch 237.
[2] ‘Study and training loan repayment thresholds and rate’, Australian Taxation Office (Web Page, 16 June 2023) <https://www.ato.gov.au/rates/help,-tsl-and-sfss-repayment-thresholds-and-rates/>; Higher Education Support Act 2003 (Cth) ss 154.10 & 154.25.
[3] Higher Education Support Act 2003 (Cth) s 137.20.
[4] Income Tax Assessment Act 1997 s 128-10.
