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Can I inherit debt? What happens to money when you die explained

Many Australians don't manage to pay off all their debt before they die, so what happens to it?

People accrue debt in many ways. Whether it’s through a HECS loan or a mortgage for a house, it's almost as inevitable as death and taxes.

"Most Australians carry debts which may be manageable in life but can become a major problem after we die," shared Aaron Zelman, founder and CEO of Willed. “Some people naively think they can leave assets to loved ones and that the debts become someone else's problem altogether.”

Unfortunately, most people are not in a position to pay off all their debts before they die. So, the big question is: what happens to these debts? Do grieving loved ones inherit them, or are debts written off and forgotten?

Funeral service in the rain. debt
What happens to debt after we die is a common concern for many Australians. (Source: Getty) (Getty Images)

Does debt disappear when I do? Or can it be inherited?

According to Zelman, debts don’t simply disappear where a mix of assets and debts are left in a deceased estate.

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An "estate" refers to any asset or property left behind by the deceased. In the Australian system, when people die, the estate is used to pay a person’s debts.

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It is the job of the executor of the will (or administrator, if there is no will) to pay off any debts and distribute the remaining assets of the estate to beneficiaries. The executor must pay the debts owed if there is money in the estate, or liquidate (or sell) the estate’s assets to do this.

If there are insufficient funds, debts may not need to be paid. However, this would depend on the kind of debt that remains.

Does it matter what kind of debt I have? Secured vs unsecured

Not all debt is the same. When talking about debt, there are generally two types: secured and unsecured. The main difference between the two is the presence - or lack - of collateral to support the loan.

Secured debt is supported by an asset that can be sold in order to repay it. These are the loans we take to buy assets such as a house or a car.

Unsecured debt is debt not tied to an asset. Loans that fall under this category are your HECS/HELP loans, credit card debt, personal loans, medical bills, and even your utility bills.

Woman's hand puts Australian $100 bills in a purse.
Most often a person's remaining debt is paid off from their estate when they die. (Source: Getty) (Getty Images/iStockphoto)

What debt is paid first when someone dies?

It’s been established that debts need to be paid before any estate can be distributed to beneficiaries. However, there is also a hierarchy that dictates which debts are to be paid first.

It may come as a surprise, but any outstanding tax is the first bill on the list.

“The Australian Taxation Office is a creditor, like everyone else, and if there are assets available to pay that liability, then it must be paid,” Willed Head of Legal Ari Morris explained. "It’s the responsibility of the executor or the administrator to file the final tax return."

Tax can be followed by funeral fees and estate administration expenses before other liabilities. Remaining debts are then arranged according to priority, with unsecured debt usually at the bottom of the list.

If the deceased estate is insolvent – which means there isn’t enough money in the estate to pay off all the debt – next of kin are not required to pay off the debts, including taxes.

Can debt be inherited?

Generally speaking, debt cannot be inherited. But there are exemptions to this rule.

If there aren’t enough funds to cover the full cost of the debt, this is usually written off, unless it is a guaranteed loan or if a loan was made through a joint account. Another way a loan can be inherited is if it was secured against an asset owned by someone else.

If the debt was guaranteed, the guarantor made a legally binding agreement to repay the debt in the event that the borrower defaulted on the debt. The guarantor, therefore, will need to repay the outstanding portion of the loan.

This is the same if a debt is in joint names – usually secured with a partner or a spouse.

If the loan was secured against an asset owned by someone else, the lender can acquire ownership of the asset to recover the debt.

Can life insurance or superannuation be used to pay debt?

According to University of New South Wales law professor Prue Vines, life insurance and superannuation are not used to pay off debts.

“Generally, life insurance and superannuation are not supposed to be used to pay off debts apart from funeral and testamentary expenses. This can be changed, but that is the basic position,” Vines explained.

Life insurance and superannuation are payments typically paid directly to a beneficiary, which bypasses the estate and is, therefore, not accessible by creditors. If, for whatever reason, these end up as part of the estate, it is only then that it is possible for it to be used to pay off debts, according to Morris and Zelman.

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Not enough money in the estate

If there is not enough money left in the estate to cover the debts, bankruptcy or estate insolvency rules apply.

“When the deceased dies in debt and there is not enough money to pay the debts, the estate has to be administered in bankruptcy or under the bankruptcy provisions of the Succession Act (or its equivalents around Australia),” according to Vines.

Australians who are concerned about debt are encouraged to seek independent financial advice or engage a wills and estate lawyer.

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