Do you inherit debt from your parents?

Falling Canadian dollars coins or loonies are pictured in North Vancouver, B.C. Wednesday, May 29, 2019. THE CANADIAN PRESS/Jonathan Hayward

After losing a parent or both parents, the last thing most children want to hear is that they have to take on debts owed by their parents. While this doesn’t happen often, it’s a very real possibility, especially if the parents don’t take proper measures to keep assets safe from creditors.

As household debt levels continue to grow, protecting family assets is more important than ever.

Below, I’ll discuss what types of parental debt can be inherited and what assets are generally safe from creditors.

WHAT KIND OF DEBT CAN YOU INHERIT?

Note that all references to children or a child below can refer to either an adult or minor child. When a parent dies, their children generally don’t inherit their parents’ individual debts. Some examples of debt that a child won’t inherit:

• Credit card debt
• Personal loan debt
• Student loan debt
• Auto loan debt
• Mortgage debt

As long as the debt is not from a joint account or a co-signed loan (more on this below), the debt is usually dissolved once the individual passes away.

WHAT HAPPENS TO DEBT WHEN SOMEBODY PASSES?

Unfortunately, debt doesn’t always disappear after an individual passes. Shortly after their passing, creditors may actively pursue eligible debts that are owed to them by contacting the executor of the deceased’s estate.

In the case of unprotected money and assets, the executor is often required to settle debts before disbursing the remaining funds and assets among the beneficiaries named in the deceased’s will.

Keep in mind that inheritance laws and regulations can vary by province and territory.

While this may not directly result in children inheriting their parents’ debt, it can greatly reduce their expected inheritance.

More than half of Gen Z and millennial Canadians claimed that they were counting on an inheritance to help them meet their financial goals, according to a recent study by Pollara Strategic Insights.

If their inheritance is drained before it gets to them, these beneficiaries could find themselves in a less-than-ideal situation.

WHAT PARENTAL DEBT CAN BE INHERITED?

The problems don’t always end there, though. In some cases, children can inherit debt from their late parents, which could put them even further in the hole. The following are common debts that the children of the deceased may inherit.

Debt from joint accounts

Children who have a joint account with their parents may be required to repay any debt incurred by the account. Some common examples of this could include:

• Joint credit cards
• Joint lines of credit
• Joint loan on a property
• Joint investment account
• A negative balance on a joint chequing account

As a co-signer, the child accepts 50-50 responsibility with their parent. Once the parent dies, the child becomes solely responsible for the remaining debt on the joint account.

DEBT FROM CO-SIGNED LOANS

The same applies to co-signed loans. It’s not uncommon for children to co-sign a home loan, personal loan, or even a small business loan for a parent. If the parent dies before the balance of the loan is paid in full, then the child could be responsible for the remaining debt owed on the loan.

Home equity loans from inherited homes

A home equity loan allows homeowners to borrow money from the bank using the equity in their home as collateral. Homeowners may often take out a home equity loan to improve their home, pay for repairs, or cover other debts they may owe.

Often parents may will their home to their children. If the deceased still owes money on a home equity loan, the beneficiary may be held responsible for the remaining debt on the loan. For example, if your parents die after having taken a $100,000 loan out of their home equity, the beneficiary of the house will be held responsible for that debt.

If the child cannot pay off the home equity loan, they may have to sell the home to cover the remaining balance or rent it out until payments on the loan are complete.

WHAT ASSETS ARE SAFE FROM CREDITORS?

Thankfully, some assets may be safe from creditors if the parent dies with debt owed.

RRSPs and RRIFs

Retirement Savings Plans and Registered Retirement Investment Funds may be protected from debt collection in some circumstances. For example, if the deceased names their child (or another family member) as the beneficiary for their registered account, it will be passed directly to them.

However, if the deceased fails to name a beneficiary, the registered account will be included in the deceased’s estate. If the RRSP or RRIF balance is issued to the estate, then creditors can pursue the debt.

This is why it’s important for individuals to begin their estate planning as early as possible.

Life insurance benefits

Creditors cannot pursue life insurance death benefits paid out to beneficiaries.

This may be indirectly possible if the beneficiary also held a joint account or co-signed a loan for their parents. In this case, the beneficiary may be required to pay the debt after they’ve received their death benefit. However, the death benefit itself cannot be garnished and is paid directly to the beneficiary.

For example, if you are paid a $1-million life insurance death benefit payout for your parents after they die, that money will go directly to you. However, if you owe $500,000 from a joint account debt with your parents, you might have to use that money to pay for that debt.

Living trust

If a living trust is created during the parents’ lives and their children are named beneficiaries, the trust's assets may be safe from creditors. A living trust in Canada, also known as an inter vivos trust, is a legal relationship you set up during your lifetime, where the settlor transfers ownership of certain assets to the trust, which is managed by someone you trust (the trustee) for the benefit of other people (the beneficiaries).

As an example, let's say Mary and John are parents to two children, Bella, who is 10 years old, and Ethan, who is 7. Mary and John have built up a successful business over the years and have accumulated substantial savings. They want to ensure that their children are taken care of financially, even if something were to happen to them.

Mary and John decide to set up a living trust. They transfer their business and their savings into this trust. This means the business and savings are no longer in their names but rather belong to the trust.

They appoint their long-time friend and business associate, Lisa, as the trustee. Lisa is responsible for managing the trust assets, which includes running the business and investing the savings.

If the living trust is structured correctly, it could protect the children from creditors in the event of their parents' death.

SEEK PROFESSIONAL ADVICE IF UNSURE

Whether you're a child whose parents recently died or you’re a parent planning your estate, I recommend seeking professional advice and guidance. Estate planning can be tricky, and if you want to ensure that your legacy is secure, you’ll need to ensure that your estate is properly structured.

Christopher Liew is a CFA Charterholder and former financial advisor. He writes personal finance tips for thousands of daily Canadian readers on his Wealth Awesome website.