Debt follows us to the grave, but understanding what happens to it thereafter is critical to effective estate planning. To a large extent, what happens to your debt depends on your estate’s solvency, the type of debt owed by the estate, whether the debt is guaranteed or co-signed, the nature of one’s marriage contract, and the terms of your will. In this article, we provide answers to a number of commonly asked questions about debt in a deceased estate.
What happens to the debt in a deceased estate?
The answer to this is not a simple one as it depends on a number of factors. However, at the outset, it is important to understand the important role that the executor plays in handling debt in a deceased estate, and the extent of their mandate in terms of managing the financial affairs of the estate.
All assets, income and liabilities of the deceased person are referred to as a deceased estate, although it is important to bear in mind that ‘deceased estate’ is a legal term and not a person. Once a death is reported to the Master of the High Court, the first job is to appoint an executor to the estate who thereafter becomes the estate’s legal representative. Keep in mind that the executor is not liable for the debts in the estate but is rather mandated to act on behalf of the estate in winding up its financial affairs.
As such, one of the executor’s first jobs is to place an advert in the local newspaper and Government Gazette calling for creditors of the estate to lodge their claims against the estate within a period of 30 days. Remember, credit does not die and continues after the death of the debtor, meaning that creditors have a right to claim from the deceased’s estate. Remember, the executor is obliged to pay all the estate’s debts before distributing anything to their heirs or legatees of the deceased.
Is the debt secured or unsecured?
When assessing the debt in the deceased estate, the executor will need to determine whether the debt is secured or unsecured as this will have bearing on how it is settled. A secured debt is one against a particular asset such as a property. When you borrow money from a bank to finance your home, your bank holds your home as security should you default on your home loan repayment. If you stop paying your bond, the bank can repossess your home and sell it to pay off your debt. On the other hand, unsecured debt is not protected by an asset and can include debt such as credit card and retail debt. If you default on your credit card payments, there is no asset that the bank can repossess and sell, and they will need to follow the normal debt collection procedure to recover the debt.
Is there a co-signatory to the debt?
Another factor determining how the debt will be dealt with by the executor is if the debt is held jointly. For instance, if a couple has a joint credit card, the surviving spouse can be held responsible for part or all of the debt in the credit card. If there is not sufficient liquidity to settle the credit card, the surviving spouse may be held responsible for the full amount owing. This is because, where debt is shared with another person, all signatories to the debt are responsible for repaying it.
Is the debt guaranteed by someone?
If someone has signed as guarantor to the deceased’s debt, that person may be held personally liable for settling the debt if the estate is found to lack liquidity.
How was the deceased married?
If a couple is married in community of property, both spouses remain jointly and severally liable for all the debt in the estate, including any debt that was incurred before the date of marriage. Upon the death of the first dying spouse, the joint estate is dissolved on the basis that a joint estate cannot have one owner. In doing so, the executor will settle all the debts in the estate, including home loans, credit cards, and contractual debt. Once all debt has been settled, the surviving spouse has a claim for 50% of whatever is left, being their half share of the net estate.
Can the proceeds of a life policy be used to settle debt?
This depends entirely on how the life policy has been structured. Where the deceased has a life policy in place and has nominated their estate as the beneficiary, the proceeds of the policy will be paid into the deceased estate. In doing so, they will be taken into account when determining estate duty and executor’s fees. In such circumstances, the proceeds can be used when settling the estate’s liabilities.
However, where the deceased has nominated a beneficiary to their life policy, the proceeds will be paid directly to the beneficiary in the event of their death and will therefore circumvent the estate. As such, life insurance policies can play a critical role in ensuring that there is sufficient liquidity in an estate to settle the debt, although the correct structuring of such policies is paramount. Remember, the forced sale of an asset to cover the debts in an estate is never ideal as it is less efficient, riskier, and more time-consuming, and can significantly delay the winding-up process. Further, a forced sale could have unintended CGT consequences for the estate.
What happens if the estate is illiquid?
Although an estate might be solvent, a common problem that many executors face is that of illiquidity which is where an estate lacks sufficient liquid assets to cover its debt and other financial obligations. In such circumstances, the executor will look to assets in your estate that they can realise such as property, vehicles, collectables, and equity. Selling off assets that were intended for the benefit of the deceased’s heirs and legatees can have devastating financial consequences for the loved ones left behind and can leave them in a financially vulnerable position.
What happens if there is debt on the asset?
If a couple jointly owns a bonded property and the surviving spouse is unable to make the monthly bond repayments, the property may be repossessed by the bank. Where bonded fixed property is bequeathed to your children, they may be required to register a bond over the property in their own name and, if they do not qualify for a bond, they may be forced to sell the property. Once again, this type of situation can be avoided through the effective use of life cover when it comes to estate planning.
What happens if the estate is insolvent?
Once the executor has finalised the liquidation and distribution account and determines the estate to be insolvent, the executor is required to notify the creditors in writing of the insolvent status, following which the estate will be handled according to Section 24 of the Insolvency Act in conjunction with the Administration of Estates Act.
Has the deceased made provision for their spouse and/or children?
Another important factor that the executor needs to take into account when winding up an estate is whether the deceased has made adequate financial provision for their surviving spouse and/or minor children. In terms of common law, a minor child can bring a claim for maintenance against the deceased estate where they have not been adequately provided for. Similarly, where the deceased has not made provision for their surviving spouse, they are able to claim against the deceased estate in terms of the Maintenance of Surviving Spouses Act for reasonable maintenance. What is important to bear in mind is that these claims outrank all other claims, including those of the deceased’s heirs and legatees.
Making provision for one’s debt is an essential part of estate planning, and failure to do so can leave your loved ones financially compromised. As such make sure that your estate planner prepares a detailed liquidity analysis to ensure that all debt and financial obligations can be met without compromising your loved one’s inheritance.