What Happens To Our Debt When We Pass Away?

In 2019, the average UK household debt stood at around £15,400. But what happens to unpaid loans or outstanding debt when we pass away? Will our family be responsible for making sure it’s paid? Will they be forced to take on this financial burden or does our debt die with us? 


The answer to this question isn’t so straightforward. Whether your family will experience financial consequences associated with your debt depends firstly on the type of debt. Whether or not you have joint loans with a partner, spouse or someone else will also affect the situation.


Your estate could be used to cover outstanding debt


It is the responsibility of the executor to make sure your debts and certain bills are paid and taken care of before your family receives their share of your assets.


Certain outstanding debts could take priority before your estate is distributed among your family. So, the inheritance you’re leaving your family, if any, could be affected by your debt if your estate is used to subsidise this debt. Depending on how much inheritance you have left behind and the size of your debt, your money could run out before it has reached your chosen beneficiaries. 


Will your life insurance policy be used to pay off your debts? 


With Smart, you will be asked to name a beneficiary (the person or people who will receive the lump sum upon your death) when you take out your policy. If for one reason or another you do not name a beneficiary, your payout could be considered part of your estate to be distributed along with your will and other assets. In this scenario, the proceeds of the life insurance policy might form part of your estate and therefore could be used to pay off your outstanding debts. 


Since a life insurance policy could be considered when calculating the sum of an individual’s estate and could be subject to Inheritance Tax (IHT). If you would like to help protect your beneficiaries from covering the costs associated with IHT, you could consider having your life insurance policy written into a Trust. 


Under what circumstances could someone find themselves responsible for your debt? 


There are certain circumstances where your family may not be forced to inherit your debt, debt isn’t just written off when we pass away. Some debts must be paid off by your estate when possible. Joint debts could also become the sole responsibility of the remaining party. To get a better grasp of this, let’s look at the differences between individual and joint debt.


Individual debt


This is when an individual takes out a loan or credit agreement in their name and theirs alone. Outstanding credit card debt could fall under this category. Sometimes, a deceased individual’s estate can be used to pay the unpaid debt before the inheritance makes it to family and friends. There is no reason why another individual will be responsible for paying this kind of debt off since it was taken out by an individual, independent of anyone else.


A joint debt is a whole other kettle of fish. This kind of debt occurs when two or more people have taken out a joint debt like an overdraft, a joint current account or a joint mortgage for example. Generally, if another individual consents to becoming a loan guarantor, they will be listed on the credit agreement. This means that if you pass away unexpectedly, they may have to pay the outstanding payments. This could be a spouse, a partner, even a friend who could be liable to pay the remainder of the debt.


If you pass away before having paid off a large debt, your family may find it difficult to keep up with payments. This could then result in the loss of a family home or other assets. If this is a concern for you, you could look into taking out a life insurance policy to help protect your loved ones should the unthinkable happen.


Your family could then choose to use the money you leave behind to pay off some or the entire remainder of your mortgage (depending on the benefit amount).


Secured and unsecured debt


A secured debt is a debt that can be taken out against your home or another asset. If you have a joint unsecured loan, and you pass away before it’s been paid, your share of the remaining debt will become the responsibility of the other party.  Otherwise, they could lose the asset against which the loan was taken out such as your car or home.


Unsecured debt is often paid back over time in instalments, like a student loan. A creditor who provides this type of loan can’t seize your assets if you can no longer afford to repay the loan. This kind of debt cannot be passed onto anyone else.


How could life insurance help with debt?


If you leave a life insurance policy behind for your loved ones, they could use the death benefit to help manage outstanding debt such as mortgage repayments and avoid losing the asset in question. This is also applicable to joint loans you have with a family member or friend.


Since your other assets (e.g. money in savings accounts) could be used by the executor to pay off certain debts before it reaches your family, it could be a good idea to leave a life insurance policy behind for your loved ones as the benefit amount will be directly paid to your named beneficiaries.


Hopefully, this has helped address your concerns around what could happen to your debt when you pass away. Bear in mind that this is not legal advice. If you would like to know more about your family taking on your debt when you die, or you would like to find out more about placing your life insurance policy into a Trust, seek professional legal advice.