Beneficiaries don’t inherit debt but they may not inherit a gift if an estate has too much debt and not enough assets. It’s the Max Smart estate plan: miss it by that much!
There are a couple of ways that an estate can come up short: assets are less than debts or assets are less than the sum of debts and gifts.
In the first case, where debts are greater than assets, the executor of an insolvent estate will have to negotiate with creditors to come up with a plan to partial pay with what is available. When an estate is bankrupt, a bankruptcy trustee takes the place of executor. Either way, all assets are applied to debts.
What happens when there aren’t enough assets to satisfy both creditors and gifts? Debts still have to get paid in full so the gifts must abate, or reduce, rateably, and in a certain order. Unless the will provides otherwise, the order of abatement is generally as follows:
1. Residual gifts (e.g., the gift of whatever is left after payment of debts and any other gifts);
2. General legacies (e.g., cash gifts);
3. Demonstrative legacies (e.g., gifts of the balance of a particular account or proceeds of sale of a particular asset);
4. Specific gifts (e.g., jewellery, artwork, vehicle, etc.)
Each class of gift abates until it is reduced to nothing and, if still not sufficient, the abatement moves onto the next class of gifts.
By way of simple example, consider an estate that has $25,000.00 in assets and $5,000 in debt. The will provides for $5,000 give to each of five grandchildren and residue to children. With a net $20,000, there isn’t enough to satisfy debts and all gifts.
In the administration of such an estate, the debt is paid in full, each grandchild’s gift abates by 1/5 to $4,000 and the residual beneficiaries are left with nothing.
The same abatement occurs even if we add a valuable asset that is specifically gifted because specific gifts are last to abate and the cash gifts in our example can abate sufficiently to cover the debt.
Assets and debts change and it’s difficult to know precisely how much you will owe and how much you will own on death. In order avoid unintended consequences of abatement, it is important to review your will from time to time and the various gifts you make in it with your professional advisors; particularly when there is a significant change in assets or liabilities.
Adam Kowalsky is an associate at the law firm of Cobb & Jones LLP. For more articles, visit the library page at www.cobbjones.ca