What Happens to Your Debt When You Die and How Life Insurance Can Help¹

Did you know your debts still need to be repaid after you pass away? Any outstanding payments could fall to your loved ones to deal with, which may disrupt their own finances and goals.

So how can life insurance help? It could be a useful way to protect yours and your family’s finances. The death benefit that gets paid after you pass away can cushion your loved ones from financial burdens, like your debt. It helps to ensure that your loved ones’ financial well-being is protected.

The State of Your Debt

Your debts don’t just disappear when you pass away. Instead, your estate becomes responsible. An estate is comprised of all assets you have at the time of death. These assets can include:

• property
• investments
• personal belongings
• monetary savings

You should have named an estate executor in your will. This person is usually responsible for resolving your debts using your assets. They will need to determine how much debt needs repaying by consolidating credit statements, looking at the credit history and even working with legal or financial advisors. To settle the debt, your executor may need to sell assets, liquidate investments or draw upon any readily available cash, such as savings.

However, the available assets may not be enough to cover all the debts. In cases like this, whatever debt remains could be written off as a loss by the creditors. Despite this, if the debts were held with another party, such as a spouse, the repayment responsibility may fall to them.

Debt Settlement After Death

Under Canadian law, the estate of a deceased individual is obligated to clear any existing debts¹ before your beneficiaries can receive any assets. Once the estate is debt-free, your estate’s executor can divide the remaining assets among your beneficiaries.

Typically, the estate’s assets are first used to cover funeral costs. The settlement of taxes owed to the relevant province or territory comes next after paying any taxes owed to the Canada Revenue Agency (CRA).² Your estate may also need to pay general creditors, such as banks and credit card companies, if you have any outstanding debts. These institutions are generally entitled to receive payment, but they must first  lodge a claim with the estate in order to qualify.

Secured credeitors, those with debts backed by collateral, typically have priority over the estate’s assets. This enables them to recoup the amounts owed. For instance, a mortgage lender could claim up to the value of a mortgaged property from the estate. However, if the sale proceeds cannot cover the mortgage, the lender then ranks as an unsecured creditor and will fall behind any remaining secured creditors in priority.

Once all general creditors have been paid, the remaining assets are divided among the beneficiaries as outlined in the will. This process ensures all financial obligations are met before assets are distributed.

Life Insurance and Debt Protection

Life insurance can play a strategic role in safeguarding your loved ones’ financial well-being after you pass away. The death benefit is a specific amount paid to the named beneficiaries upon your death. Your beneficiaries can use this payout to settle outstanding debts and meet other financial obligations. It can act as a safety net for your loved ones, so they don’t need to repay any debts or cover other expenses out of their own pockets.

Purchasing a life insurance policy that is equivalent to, or more than your outstanding liabilities could help cover your mortgage or substantial credit card debt.

For example, if you have $20,000 worth of total debt when you pass away, a life insurance policy with a death benefit of $30,000 could cover these debts and leave $10,000 for beneficiaries or other final expenses.

This approach can serve a dual purpose. Not only can it shield your loved ones from having to shoulder the financial burden of unsettled debts, it can help provide much needed financial stability during times of grief.

Types of Life Insurance for Debt Protection

Term life insurance

Term life insurance offers coverage over a fixed period, such as  10, 20 or 30 years.

You could purchase term life insurance later in life to shield your loved ones from taking on your debt. Your term life death benefit could be used to settle outstanding debts, cover other expenses and protect your assets.

Permanent life insurance

Permanent life insurance will last your lifetime. You may wish to  purchase a whole life insurance or universal life insurance policy.

A key feature of most permanent life insurance is its cash value component. This is like a savings account with the policy that grows over time and, subject to the terms of the particular product or policy, can be tapped into with loans or withdrawals. The death benefit serves the same purpose as it does with term life insurance – your beneficiaries can potentially use it to settle lingering debts and other financial obligations.

Sources

¹ https://davidsklar.com/blog/death-and-debt-ontario/ (2023)

² https://www.nbc.ca/personal/advice/succession/canada-estate-taxes.html (2023)

Footnotes

^TM Canada Protection Plan and the logo are a trademark of Canada Protection Plan Inc. from Foresters Financial. No medical, simplified issue life and critical issue life insurance underwritten by The Independent Order of Foresters or Foresters Life Insurance Company. Foresters Financial is a trade name and trademark of The Independent Order of Foresters (a fraternal benefit society, 789 Don Mills Road, Toronto, ON, Canada M3C 1T9) and its subsidiaries.