If like thousands of families in the UK, you have unpaid loans or outstanding debt, you might be wondering what will happen to your debt when you die. Will your family be responsible for paying it or will your debt die with you?
What happens to our debt when we die?
If you’re planning on leaving your estate to your family, it is the responsibility of the executor to sort out your debts and make sure certain bills are paid. This must happen before your assets can be distributed amongst your loved ones. For this reason, the inheritance you leave your family can be heavily affected if your estate is used to subsidise your outstanding debt. In some cases, money left behind can run out before it reaches anyone named in a will or chosen beneficiaries.
If you take out a life insurance policy, you’ll have to name a beneficiary. The person or people you appoint as beneficiaries on your policy will inherit the cash lump sum that the insurance company pays out following your death. If there is no named beneficiary, the life insurance payout would go into the policy holder’s estate and would then be distributed according to their will, along with any other assets.
In this case, the proceeds of the life insurance policy might form part of the estate and could be used to pay off the outstanding debts. This will depend on the terms and conditions of the policy and how it was set up.
Life insurance policies, like other assets, are normally considered part of a deceased person’s estate, and as a result, a substantial part of the proceeds of a policy can be taken in order to pay Inheritance Tax (IHT) liabilities. If you want to protect your beneficiaries from costs associated with IHT, it is possible for a life policy to be ‘written in trust’. Normally life insurance policies are taken out for family protection or mortgage protection and usually will form part of the individual’s estate for IHT calculation.
If no estate has been left, then the debt will die with the deceased individual. But under what circumstances could someone find themselves responsible for your debt?
Will my family take on my debt when I die?
In the UK, in many cases, you don’t have to worry about your family inheriting your debt. They won’t be forced to take on the responsibility of your outstanding debt, such as credit card bills for example. That being said, debt isn’t automatically written off when we die either. Some debts must be paid off by the estate of the deceased individual and joint debts will likely become the sole responsibility of the surviving partner.
Individual vs joint debt
An example of individual debt is where one individual has taken out credit or a loan in their name - unpaid credit card debt often falls under individual debt for example. In some cases, a deceased person’s estate may be used to pay the outstanding individual debt before it reaches friends and family. Nobody else will become responsible for paying this kind of debt.*
Joint debt is where two or more people take out a joint debt under all their names. This could be a joint current account with an overdraft or a joint mortgage for example. If someone consents to become a loan guarantor or they are listed on a credit agreement while you’re still alive, they may have to take on the burden of repaying the outstanding payments. This could be your partner, parents or even a friend who could end up being liable to pay off the remaining sum of money owed.
If you die before you’ve paid off any large loans or debts, would your family struggle to keep up with the monthly payments? Failing to keep up with loan repayments could result in the loss of their home or other assets. If you’re concerned about this happening, mortgage life insurance could help you to protect your family financially.
Secured vs unsecured debt
A secured debt is when a loan has been taken out against an asset like say a mortgage or a car loan. In the case that someone has a joint secured loan, the deceased’s share of the debt is passed on to the other individual. This individual will be expected to repay the remainder of the loan or face losing the asset against which the loan was taken out i.e. your home or car.
Unsecured debt is one that is paid back in instalments like say a student loan for example. Creditors who provide this kind of loan cannot seize your assets if you cannot afford to pay the loan. An individual debt of this kind cannot be passed on to anyone else.*
Life insurance or mortgage life insurance can always be used to help out with any debt you’ve left behind. Alternatively, it can be left to your family, and excluded from your estate (meaning it can’t be used to pay off your outstanding debt). You could do this by placing your life insurance policy into a Trust.
How can I protect my family against my debt?
In some cases, you could use life insurance to help protect your family against unpaid loans and outstanding debt. If you have a mortgage, you can always think about taking out a life insurance policy to help protect your family from losing their home if you pass away unexpectedly.
Now we’ll take a quick look at two types of life insurance that could help you protect your loved ones from your debt:
Mortgage life insurance can be used to protect your family until your mortgage or a large loan has been repaid in full. As you repay your loan, potentially your need for insurance decreases over time. That’s why a decreasing term life insurance policy like mortgage life insurance which reduces over time could be a suitable choice in this situation
Term life insurance can also be used to protect your family in the event of your death. Unlike mortgage life insurance, term life insurance doesn’t decrease over time. You choose a benefit amount and if you keep up with your monthly premiums, your family will receive a lump-sum payment when you die. The cash lump sum payout belongs to your legal beneficiaries, this can in some cases be a creditor if they have been named as a beneficiary.
Will my life insurance policy be used to pay off my debts?
In some cases, yes your family may choose to use the benefit amount they receive from your life insurance policy to pay off outstanding debt such as a mortgage. If you have a joint loan with a partner or another family member, they may become responsible for paying the remainder of the debt.
There’s also the possibility that your estate i.e. your assets excluding your life insurance policy, will be used to pay off your outstanding debt. Sometimes debts will get priority before your assets are given to your family. In the case that you have a mortgage, your family are at risk of losing their home if they fail to keep up with mortgage payments following your death.
In many cases, the benefit amount from a life insurance policy is paid directly to nominated legal beneficiaries meaning it does not become part of the deceased’s estate. In the case that there is no named legal beneficiary, the policy could be considered part of the estate. This will depend on policy terms and conditions.
A level term policy could be worthwhile considering if you simply want to leave something behind to help with living costs and other such things. A decreasing term policy like mortgage life insurance could be suitable for protection against an unpaid mortgage or another type of debt that grows smaller over time.
This blog should have answered some of your questions about what might happen to your debt after you die, but it is not intended to be legal advice. If you’re concerned about your family taking on your debt after you die or you would like to write your life insurance policy into a Trust, it’s a good idea to seek professional legal advice to find out how you can best protect your loved ones
* Money Advice Service, Dealing with the Debts of Someone Who Has Died, moneyadviceservice.org.uk