Surveys have shown that two-thirds of Canadians do not understand what happens to debt after death. It can be an uncomfortable subject to ponder, but understanding how debt works in the context of death is essential to financial and estate planning.
If a family member of yours was to pass away suddenly, would you inherit their debt? Can creditors pursue you to collect any outstanding balance owed, or does the debt automatically disappear?
Similarly, if you have a family, will they get saddled with your debt obligations if you die? If so, how can you avoid passing down your debts to your spouse and children?
To understand the financial implications of these questions, it’s worth becoming familiar with what happens to unpaid debts when a borrower passes away.Let’s Talk
Do you inherit someone’s debts after they die?
In Canada, you don’t inherit someone’s debts after they die if you’re listed as a beneficiary in their will. Instead, the deceased individual’s estate will pay off any debts owed to creditors. One exception is for debts you owned jointly with them – these will now be your responsibility to repay.
How debts are settled after a person’s death
When someone passes away, their assets and liabilities become part of their estate, which the law treats as a legal entity, much like a corporation. The purpose of an estate is to distribute the deceased’s net proceeds per their will and specific legislation where applicable.
The individual in charge of managing the estate and facilitating the distribution of its assets is called the executor. Typically, this individual is a lawyer or a family member of the deceased.
The executor receives the authority to administer through a legal proceeding called probate. The probate process involves several steps, but primarily its purpose is to validate the departed person’s will, allowing for the orderly distribution of their estate’s assets.
Who gets paid first?
Under Canadian law, a deceased person’s estate must pay off that person’s debts before the beneficiaries receive anything.
So, even though debts don’t transfer to you after a family member’s death, that doesn’t mean they’re forgiven. The deceased person’s estate must use its assets to satisfy creditor demands. Once all debts are settled, you and the other beneficiaries will receive what’s left of the estate’s assets.
In Canada, an estate first pays out its assets to settle funeral expenses. Then it pays taxes owing to the Canada Revenue Agency (CRA), followed by taxes due to the province or territory.
General creditors such as banks and credit card companies are next in line to receive payment for outstanding debts. To be eligible, they must file a claim with the estate.
Secured creditors have priority on the estate’s assets to the extent they can use them to recover outstanding debts. For example, a mortgage lender can pursue an estate up to the value of the property purchased with the mortgage.
Suppose the proceeds from the sale are insufficient to cover the entire mortgage. In that case, the lender becomes an unsecured creditor and falls behind any other secured creditors.
Any assets in the deceased’s estate after general creditors have received payment goes to you and any other beneficiaries who appear in the will.
Note: Certain assets could be shielded from seizure by creditors. These include RRSPs, TFSAs, and life insurance policies. If the deceased persons named you as a beneficiary on these accounts, the assets would transfer to you automatically. Jointly held assets will pass to you directly, as well.
Cases where you’ll inherit debt after someone’s death
Some exceptions exist to the rule that you cannot inherit debt in Canada.
Let’s say that you cosigned a loan, such as a joint credit card, with an individual who dies. In this case, any remaining balance on the account will be your responsibility to repay.
The most common instance of debt transferring from one person to another is in the case of a married or common-law couple. Typically, both individuals will share liabilities, much like they would share joint bank accounts. Thus, you could wind up solely responsible for your spouse’s debts.
The other exception to inheriting debt concerns taxes (no surprise, right?!). When a person dies, the CRA deems them to have sold their property at fair market value, which may produce capital gains on their final tax return. Let’s say you receive some or all of this property, but the applicable tax remains unpaid. In that case, the CRA can legally pursue you for the outstanding tax debt.
What happens to mortgage debt after death?
Inheritances rarely consist of only cash. The vast majority of wealth in Canada is in real estate. As such, a home is often the most valuable asset a person will pass on to their beneficiaries.
When someone dies with debt, their home equity and equity in any other real estate they own individually becomes part of their estate.
The mortgage lender will be the first creditor to collect against that property. But what if there’s no mortgage balance left, with only home equity remaining? In that case, other creditors may collect unpaid debts against the home equity.
If you inherit a home with an outstanding mortgage, you can legally take ownership of the property. However, this is conditional on you also assuming ownership of the debt.
In this situation, it can seem like you’re inheriting debt. But the executor of the will has the power to either sell or pass along an asset.
Let’s assume the property is underwater (i.e., the amount owing is higher than the current market price). If that’s the case, the executor can arrange for the sale of the home and keep it in the estate. As a result, the remaining mortgage debt will be forgiven without being passed on to the will’s beneficiaries.
Taking on that mortgage debt oneself can be risky. If you accept responsibility for the mortgage and sell without recouping the debt, the only way to have the remainder forgiven would be to file bankruptcy or a consumer proposal. Bankruptcy can involve having to surrender property to creditors and having to make surplus income payments.
What happens to credit card debt after death?
A credit card company is usually the last creditor to get paid from an estate. As such, the estate may lack the money to cover the credit card debt. In that case, the debt disappears. As a family member of the deceased individual, you won’t inherit the remaining balance.
However, issues may still arise concerning card accounts with multiple users. For example, let’s assume that you’re the surviving spouse to whom the deceased has provided supplementary credit cards. In this scenario, the creditor may insist that you repay the balance owing on the account. But if you never cosigned or guaranteed the debt, you’re likely not responsible for paying them.
In some cases, a cardholder will have purchased a credit card insurance policy for their account. Thus, if they die, the insurance provider will clear any outstanding balance.
What happens to spousal support payments after death?
Debt and divorce in Canada are already complex, especially when the couple must split their assets and debts or spousal support payments are required. The death of one party adds another layer of complexity to the situation.
Generally speaking, spousal support ends when the support recipient dies but does not necessarily end when the support payor dies. There are cases where spousal support payments may be made out of the payor’s estate, depending on the nature of the separation agreement, as long as the estate has assets to continue those payments.
What happens if the estate’s debts exceed its assets?
If a deceased person’s debts exceed their assets, their estate is insolvent. As a result, their creditors will only receive partial payment of debts owed.
In this scenario, the executor may elect to file for bankruptcy for the estate. By doing so, they can save the beneficiaries the hassle of dealing with the complexities of an insolvent estate. Assigning the estate to bankruptcy proceedings will help streamline the orderly distribution of funds to creditors and provide protection against collection calls.
Dealing with collection agencies after a family member’s death
Sometimes, debt collectors may go after you to collect the deceased person’s unpaid debts.
Should a creditor contact you about a family member’s debt, ask them for more details. Find out the original creditor’s identity and confirm they legitimately owed the debt. Be sure to verify also whether you or another family member cosigned the loan or holds a joint account. If your name doesn’t appear on any loan contract, the creditor has no legal right to demand that you pay off the debt.
How to avoid inheriting debt
Although it’s a rare case that you’ll inherit debt in Canada, some circumstances can result in you being responsible for the loans of a deceased individual. Here are some tips to help you avoid debt when someone close to you dies.
- Refrain from cosigning a loan or applying for a joint debt account. Generally, it’s wise to avoid cosigning a loan contract for someone or opening a debt account, such as a shared credit card. If the primary borrower stops making payments, you’re legally obligated to step in and cover the balance. While it’s commendable and generous to help a family member get approved for a much-needed loan, always consider the financial ramifications. Could you manage the payments on your own? If the answer is “no,” it’s best to avoid signing your name on the dotted line.
- Take out a life insurance policy. If you decide to assist someone in acquiring a loan by entering into a joint debt agreement, consider purchasing a life insurance policy for them. The insurance provider will pay off the outstanding balance in the event of the primary borrower’s death.
- Be wary of supplementary credit cards. As mentioned previously, you generally aren’t required to pay the outstanding debt on a credit card account if you’re an additional cardholder, as long you didn’t cosign the loan contract. Still, this is a grey area. The credit card company may still attempt to extract payment from you if they genuinely believe it’s a joint debt based on the terms of the contract. Therefore, ensure you read the fine print to understand your obligations.
- Discuss the impact of debt with your family. Talking about debt in the context of death can be unpleasant. Still, it’s a necessary conversation so everyone in the family understands what to expect should someone die and leave behind unpaid debts. Develop a plan to deal with outstanding loans so that one family member’s obligations don’t become another’s burden if they pass away unexpectedly. Some solutions include allocating some inheritance to pay off debts and repaying high-interest debt as soon as possible.
Final thoughts on debt inheritance in Canada
Inheriting debt in Canada isn’t something you need to worry about for the most part. As long as you’ve never cosigned a loan contract, it’s unlikely that someone’s debts will become your responsibility to repay after they die.
Still, outstanding debts left behind by the deceased can affect any potential inheritance. Creditors have the legal right to collect proceeds from the estate to settle unpaid debts before you, as the beneficiary, receive anything.
Are you setting up your estate and want to deal with your debts so that your beneficiaries don’t have to? If so, you can learn more about potential solutions with the help of David Sklar & Associates. One of our Licensed Insolvency Trustees will review your financial situation and explain all the Canadian debt relief programs that can help you resolve your debts. Contact us today for a free no-obligation consultation – you owe it to yourself!