How Life Insurance Works in Divorce
Ongoing financial support of children or an ex-spouse may be part of the arrangements made in your divorce.
If so, consider the difficulties the ex-spouse or the dependent children may have if the party responsible for those payments has an untimely death.
While it’s possible for the surviving custodial parent to pursue several ways to ensure continued financial assistance, please review your state’s laws to understand what happens to child support payments after a parent’s death as these rules vary.
In this post, I focus on life insurance and divorce. To learn more about how life insurance works, please refer to the links in the Resources section at the end of this post. As always, please consult with your team of professionals (attorney, accountant, financial planner, insurance agent) before taking action.
Prevent an Untimely Loss of Income with Life Insurance
This is not an easy topic, and no one likes to think about it. While there are a lot of moving parts during and after a divorce, life insurance tends to be an afterthought. It is an important part of the divorce process, however, and one that should be addressed sooner rather than later. This is especially true for divorcing couples with children.
If you are the spouse with primary custody of the children and you are receiving financial support from your ex-spouse, you need to take steps to make certain that these funds will continue to be available even if your ex-spouse passes away. The most efficient way to do this is to take out a life insurance policy on your ex-spouse.
Three Distinct Roles for a Life Insurance Policy
- Policy Holder (Owner): The individual who purchased the coverage on the insured’s life and pays the premiums. The owner of a life insurance policy has control over the policy.
- Insured: The person whose life is covered by the policy. Unless the insured is the policy owner, the insured has no control over the policy.
- Beneficiary: The person or organization designated to receive the death benefit after the death of the insured.
- The policy owner and insured are often the same person, but not always.
- The policy owner and beneficiary can also be the same person.
- The insured and beneficiary cannot be the same person.
Any person (an adult, not a minor) or legal entity can own life insurance on another person as long as there is insurable interest and mutual consent (the policy owner and the insured must both agree to the policy).
Two Types of Life Insurance Policies
- Whole life and universal life policies not only pay a death benefit, but they also accumulate a cash value with each payment you make, acting as a savings vehicle that grows over time and accrues interest. The insurance company sends you regular statements (usually annually) of the policy’s value. This will need to be counted as you determine the equitable division of your assets in your divorce.
- Term life insurance policies do not have a cash value in addition to the death benefit. They simply provide an amount of money to your beneficiary if you die. These policies are usually less expensive than whole life or universal life policies, and they do not have to be considered when determining your net worth.
What’s Involved in Life Insurance and Divorce
Be sure to determine the current life insurance obligations within your divorce agreement before either of you make any beneficiary changes in existing policies.
Handling the life insurance issue during and after divorce involves some if not all of the following steps:
- Accounting for the cash value of whole or universal life policies when reviewing financial assets. Whether this type of life insurance is considered a marital asset depends on state laws.
- Purchasing a new policy if one doesn’t yet exist or adjusting an existing policy’s value to protect spousal maintenance and/or child support.
- Making needed beneficiary changes to an existing policy. When you and your spouse divorce, chances are you no longer wish him or her to profit from your demise.
Here are examples of a few situations that might occur.
Situation 1: Existing Life Insurance Policy
You are both the policy owner (paying the premiums, controlling the policy) and the insured. Your spouse is named as beneficiary.
- If you are the one paying alimony and child support, a good choice could be to keep this policy in place to help support them in the event of your death.
- If you are not the person paying alimony or child support, you may want to cancel the policy or remove your spouse’s name and add a new beneficiary. You’ll need to contact your insurance company to determine your options. If you purchased an irrevocable policy, however, you cannot change the beneficiary.
Situation 2: Existing Life Insurance Policy
Your spouse is both the policy owner (paying the premiums, controlling the policy) and the beneficiary. You are the insured.
This is a complicated situation that you’ll both need to discuss. If you decide as the insured you no longer want your spouse to have this policy on you, you’ll need to contact the insurance company to learn about your options if there is no longer “mutual consent.”
Situation 3: No Existing Life Insurance Policies
In this case, a new life insurance policy would help the recipient of alimony and child support continue to receive that financial support should the payor die before that responsibility is completed.
Arrangements to be decided for the new policy:
- Policy is owned and premiums to be paid by either spouse. If the policy is owned by the spouse receiving the child support or alimony payments, it means that spouse will always know the policy premium is paid and the life insurance benefits will be paid.
- Insured is the alimony and child support payor.
- Beneficiary is the recipient of those payments.
How Much Life Insurance Is Needed to Cover the Loss
Many clients consider that the child support and maintenance obligation should be protected by having an amount of life insurance to cover the obligation.
Simple math will tell you how much money you would need if your spouse were no longer able to make child support and spousal maintenance payments.
Let’s say, for example, that Lori and Jim have a ten-year-old child, and that Jim is paying Lori $10,000 annually in child support and $12,000 in spousal maintenance.
- Lori will receive child support until the child is 21. Jim would pay Lori a total of $110,000 in child support over 11 years.
- Lori receives spousal maintenance of $60,000 over those first five years.
Child support = $ 110,000
Spousal maintenance = $ 60,000
Total = $ 170,000
In this case, Lori may want the payout to be $170,000. Also consider that this would be supplemented by Social Security benefits for the child until age 18.
Who Pays the Life Insurance Premiums
Clients frequently discuss who will pay for the life insurance premiums. That decision usually depends on the cost of the life insurance and whether both parties have an obligation to maintain a death benefit.
Many agreements stipulate that the amount of life insurance be reduced for the next year by what the payor paid in the prior year. In my example above, the annual amount for the first five years of payment is $22,000 ($10,000 for child support and $12,000 for maintenance). For the last six years, the annual payment would be $10,000. The insurance company can provide the data of how the life insurance amount would change year-to-year in your situation.
Naming the Beneficiary of the Insurance Policy
Clients come to agreement on who should be the beneficiary of the insurance policy for the child support amount. In most cases, the custodial spouse is the beneficiary in order for him/her to continue to provide for the children’s clothes, education, shelter and the like.
In most states, children under age 18 cannot receive life insurance funds directly, so a trustee would be named, most often the other parent.
Should Each Parent Have a Life Insurance Policy?
A related important conversation is what happens if the beneficiary of this policy (usually the custodial parent) passes away, whether before or after the non-custodial parent. Today, both parents cover quality childcare and other expenses involved in supporting the children.
It might be wise for the custodial parent to be the insured on a second policy naming the non-custodial parent as beneficiary. This could cover what the custodial parent pays towards taking care of the children out of his/her own funds. A policy like this protects the non-custodial parent from having difficulty covering costs involved in raising the children if the custodial parent passes away.
Life Insurance Beyond Coverage of Maintenance and Child Support
Many clients have life insurance in excess of this particular obligation. Those “extra funds” may be able to be directed to the deceased’s estate by naming the estate as beneficiary and creating a will. Through a will, an executor (usually not the ex-spouse) would be named to manage the estate, including life insurance, house, retirement funds, and the like for the children until they reach a certain age determined by the will. This is a complex situation requiring the involvement of related professionals.
Life Insurance for Peace of Mind
Your investment professional or insurance agent can help you find an affordable policy that will provide you with the peace of mind you need as the custodial or single parent after your divorce.
- “How does life insurance work?“
- “What Is Insurable Interest in Life Insurance?“
- Uniform Transfers to Minors Act (UTMA): NOTE: While the UTMA offers a way to build a tax-free savings account for minor children, the assets will be counted as part of the custodian’s taxable estate until the minor takes possession.
- “Investopedia: How Life Insurance Works in a Divorce“
- “New York State: Consumer Life Insurance FAQs“
- New York State “Re: Minors as Owners, Beneficiaries and Donees of Life Insurance Policies“
For more divorce topics covered by BJ Mann: BJ Mann Site Content Index