New and Continuing Needs for Life Insurance in Divorce
What is it?
Do I still need to have life insurance coverage at all? More likely, you’re wondering whether you will need additional insurance to protect your alimony or child support payments. While married, you purchased life insurance as protection in case of the untimely death of yourself or your spouse. After a divorce, life insurance is still valuable protection for yourself and your family.
Many of the concerns you shared while married will still apply after divorce. Almost as certainly, divorce will also create new concerns for you and your family.
Protecting your children
Insure the life of noncustodial parent
Much of the reason you purchased life insurance in the first place may have been to protect your children. The death of the parent responsible for child support payments could have a devastating impact on your children’s financial future. The lost income could mean financial hardships for children who are dependent on the support for their basic needs and educational expenses. You will likely want to ensure that there is a sufficient amount of insurance on the life of the support-paying spouse to protect the children’s financial future.
Change the beneficiary designation
Divorce may also create beneficiary designation issues. Your former spouse is often the beneficiary of your life insurance policy. Many people overlook the need to change the designation after a divorce–in fact, it should be one of the first things you do. Designating your child as the beneficiary is one option; designating your estate is another.
Caution: Designating the estate isn’t as beneficial, however, because it could greatly increase the value of your estate and, thus, increase the potential estate tax exposure at the time of your death. As long as you live for three years after the designation, making your child beneficiary of an irrevocable life insurance trust can avoid these estate tax consequences.
Protecting your alimony/child-support payments
In general, If you are receiving alimony or child support payments, you should protect those payments by insuring the life of your former spouse. Support payments can be critical to your own well-being, as well as to your children’s. There are some options.
Be named the beneficiary of your former spouse’s policy
As part of the divorce settlement, the easiest option is to be named the beneficiary of any existing policies on your spouse’s life. This will protect you in the event of your former spouse’s untimely death.
Caution: Be aware that you will have no real control over the policy. The problem is that if your former spouse still owns the policy, anything can happen. He or she may take loans on the policy or fail to pay the premiums. There is more than one story in the big city of an unscrupulous spouse changing the beneficiary designation or taking a loan on the policy, leaving an unsuspecting former spouse with little or no protection.
Have existing life insurance policies transferred to you
Having the policy transferred or assigned to you can be a valuable alimony-protection tool. When you own the policy, you are protected from your former spouse taking loans or making any other changes to it. Another benefit of ownership is that the insurance company notifies you if the premium is not paid on time. Such a transfer should be part of the divorce agreement to avoid gift tax consequences. You may also be able to have the divorce agreement require your former spouse to continue paying the premiums on the policy transferred to you. Depending on the cost of the premiums, this can be a big help. If there’s some controversy over who will pay the premiums, think of it this way: If you pay them, you have the peace of mind to know that they are being paid in a timely fashion. Moreover, if your former spouse pays the premiums, they will likely be considered alimony and, therefore, taxable to you.
Purchase additional insurance on your former spouse
As a slightly more difficult option, purchasing a policy on your former spouse can give you the protection you need along with much more control than if you are just the designated beneficiary. If it’s too late to make any changes to the divorce or separation agreement, purchasing a separate insurance policy on the life of the former spouse may be your only option for protecting your alimony payments.
Caution: Buying life insurance can be an expensive proposition, especially if your former spouse is older or in poor health. Caution: An unwilling ex-spouse may not go along with extensive physical examinations or underwriting that may be required to purchase a new policy. It’s a good idea to make sure that the former spouse is willing to be insured before relying on this option.
Seek to have the alimony/child-support payments increased to cover the cost of additional insurance
It may be the most beneficial option for both of you to increase the alimony or child-support payments by the amount necessary to pay for a new policy. You and your spouse can agree to this as part of the divorce settlement. This option gives you total control over the policy while at the same time protecting your alimony/child support payments.
Caution: Remember that the alimony payments you receive are considered taxable income to you and are deductible by your former spouse. Notice the tax consequences in the following example.
Example(s): As part of their divorce agreement, John’s former spouse, Mary, is required to pay $500 per month in child support to John for their daughter, Abby (whom John has custody of) until she reaches age 18. Abby is 8 years old. The parties agree in the divorce settlement that the $500 includes the cost of a 10-year term life insurance policy on Mary’s life. Results: (1) The child support payments are protected until Abby reaches age 18, when they are to end normally, (2) Mary is happy because term life insurance is inexpensive, and (3) John is happy that the additional child support payments are not taxable to him as income.
Protecting yourself as the noncustodial parent
Insure the life of the custodial parent
Insuring the life of the custodial parent can protect you and the well-being of your children. If the custodial parent dies, you’re the one who will have to take custody of the children. Financially, this could be a very difficult situation. All of the costs of raising the children will now fall on you as the only parent. From basic needs to higher education, these costs can be extensive. A policy on your former spouse’s life can prove invaluable in meeting these costs.
Pre-Divorce Planning Can Go A Long Way
Consult a Professional Insurance Advisor at The Insurance Suite that can walk you through the above mentioned steps.