Inheriting Debt: Estates That Can’t Afford All of the Debt

Sometimes, a person’s estate isn’t large enough to pay all of the debt they owe to creditors from their lifetime. This is called an insolvent estate. When this happens, loved ones and beneficiaries are often worried that they will be burdened with the deceased’s debt. Beneficiaries of an insolvent estate are not likely to receive their inheritance. However, they will not “inherit” the deceased’s debt either. Barring unusual circumstances, the estate is responsible with paying the deceased’s creditors. No one else will be required to pay unless they were expected to before the testator’s death. If an estate can’t afford all of its payments, certain creditors won’t be paid in full.

Debts Owed, But Not Inherited

A misconception that people often have is that debts simply disappear upon one’s death. This is not the case. People, and their estates, are always required to pay off outstanding debts before gifts can begin being distributed to beneficiaries. In a way, the beneficiaries are indirectly ‘paying’ these debts, as their inheritance is being used to pay them. It’s important to understand that beneficiaries are never to pay debts after they’ve received an inheritance. The executor must ensure all estate creditors have been paid before distributing gifts.

When Debt is “Inherited”

You can only ‘inherit’ debt from a loved one when it is jointly owned between yourself and the deceased. For example, if you and your spouse had a joint loan, you must repay it even if your spouse dies before the balance is cleared.

Avoiding Inherited Debt for Your Loved Ones

Well, the obvious solution to preventing loved ones from inheriting debt is to not make any joint debt agreements. While this solution might be painfully obvious, it’s not always an option for some people. We would recommend not entering into joint debt agreements when you’re reaching an older age as you’re at a higher risk of passing away before the debt is repaid. In the case that you have joint debt with someone, when one of the testators passes away, the surviving person is responsible for paying the balance.

Depending on the debt agreement, some life insurance policies will cover your loved ones in the unfortunate case that you pass away before the debt is paid. There are different types of life insurance and can provide further benefits in terms of estate planning. For more information, read our blog on life insurance.

Executors Dealing with Insolvent Estates

The estate executor will be responsible for paying any debts owed on behalf of the estate, using funds from the estate assets. When the estate is insolvent, it can be complex to figure out which creditors have priority to be paid. Just like the beneficiaries of the will, the estate executor is not personally liable to pay debts that the estate can’t afford. The only time an executor is liable is when they distribute inheritances to beneficiaries before paying creditors. For more information, read our blog on the debt repayment order of priority.

In the end, debt is never passed down through the will if the estate is unable to pay for the debts owed. Beneficiaries of a will never have to pay anything to receive their inheritance and won’t have to pay any estate taxes or debts after receiving their inheritance. The only case where debt is “inherited,” is when the debt was originally jointly owed. When one of the joint debt owners passes away, the debt is still required to be paid by the surviving person.

If you’re unsure how your debts will make an impact on your estate, contact an experienced estate lawyer today. We can help you to understand the implications your debts might have on your estate and the inheritances you wish to give to loved ones.

Have a question about this topic or a different legal topic? Contact us for a free consultation. Reach us via phone at 250-888-0002, or via email at info@leaguelaw.com.