When should a debt not be paid for estate administration purposes? When the law does not allow it to be paid.
You may have heard the saying that superannuation and insurance are 'protected' assets. What does this mean in terms of estate administration?
It is important to understand that pursuant to Sections 249 (6), (7), (8) of the Bankruptcy Act, both life insurance and superannuation proceeds are property that is not divisible amongst the creditors of a bankrupt estate. This applies to both a bankrupt estate whilst the person is alive and the estate of a deceased person.
It is in the context of a deceased estate, that an executor needs to be aware of these principles.
The general principle is that if superannuation proceeds are paid into an estate and there are no other assets in the estate to pay debts (such as from cash or shares that can be sold) then superannuation should not be applied to pay estate debts.
So, if an estate has any outstanding debts, for example credit card debts or Australian Taxation Office (ATO) obligations, the executor would not be administering the estate properly if super or life insurance proceeds were used to pay those debts.
In addition, Section 205 of the Life Insurance Act states:
'monies payable on the death of a person as a consequence of a policy effected on the person's life are not liable to be applied to pay the person's debt unless the person gave an express direction in his Will or other testamentary document, that the money be so applied. An express direction is not merely a direction in the Will that debts be paid (a common clause in all properly drawn Wills) as this does not provide an express direction.'
What about the mortgage over a residential property held by the estate? Does this mean a mortgage does not have to be repaid from 'protected monies'? Yes, the same principle applies and an executor would not be obligated to use such monies to pay the mortgage.
However, the reality is that if the mortgage is not paid the mortgagee would exercise their right to sell the property to recover their debt and this is not what a beneficiary of the house would want. Hence, they would voluntarily use superannuation and life insurance proceeds to pay that debt.
This is a trap for the unwary executor!