Paying debts and liabilities of an estate must be done by the deceased’s personal representative upon that person’s death. Unfortunately, this may mean using potentially all of the estate assets to meet these payments – that is, except for the life insurance policy or superannuation fund!
Happily for beneficiaries, the legislature has protected life insurance policies and superannuation funds from being used to pay debts and liabilities of a deceased estate. Consequently, the proceeds of the policy or fund are to be carried out according to the terms agreed upon and made in accordance with a nomination under the policy, or as directed.
The same rule applies if the estate is insolvent. Under Section 116 of the Bankruptcy Act 1966 (Cth), life policies and super funds are not available to creditors.
Life Insurance Protections and Exceptions
Sections 204 and 205 of the Life Insurance Act 1995 (Cth) protects life policies from being applied or made available to pay the debts of a deceased estate.
However, this protection does not extend against funeral and testamentary expenses, which can be paid out of policy proceeds. In this regard, to avoid possible litigation, will-drafters should give careful consideration to the complex questions of apportionment required for the payment of debts, and funeral and testamentary expenses under the Will.
The only way life insurance policies can be used to pay estate debts is if the policy holder expressly directs so, either by:
- Entering into a contract that expressly provides for the money to be applied in the payment of the debts; or
- The person has charged the money with the payment of the debts; or
- Making an express testamentary direction in their will that the policy money is to be applied for payment of the debts.
Indeed, using proceeds of a life policy to pay estate debts does have some definite advantages, namely:
- Proceeds of life policies are not likely to incur Capital Gains Tax (CGT); and
- Making the life policy available to pay debts may protect other estate assets from being sold, which would incur CGT.
Making the decision to use the life policy to pay estate debts will require a holistic consideration of the estate assets and liabilities. Particularly, special care must be taken when drafting directions in accordance with the legislation. Inaccurate wording may have unintended effects upon the estate and incur unwanted tax liabilities!
Section 143 of the Superannuation Act 1922 (Cth) protects superannuation entitlements from being applied or made available for payment of estate debts.
Notably, this protection cannot be removed like the life insurance policy.
Persons who make nominations under their life policy or super fund should ensure the nomination is kept up-to-date and valid.
If you require further information on any matters contained in this article, including assistance with estate planning, we invite you to contact our office.