Life Insurance and Divorce: Protecting Your Family's Future
Sometimes in life things don't work out as planned. One of the most trying examples of this is when a couple decides they can't make their marriage work and, subsequently, file for divorce. Divorce takes a significant financial and emotional toll on both parties, their children, and other family members and friends. In the midst of the immediate financial and legal concerns, couples also need to look beyond the present to help ensure that their financial futures are secure and that the future needs of children, such as education expenses, will be provided for in the event of an untimely death. Life insurance may offer a solution.
According to the latest data from the U.S. Census Bureau, about five of every six custodial parents were mothers (82.5 percent) and one of every six were fathers (17.5 percent). In addition, the proportion of custodial mothers with income below poverty (31.2 percent) was higher than that of custodial fathers (17.4 percent). With the majority of care falling to single mothers living on relatively modest average incomes, concerns arise regarding the future needs of children. Because women traditionally spend more time out of the workforce than men because they are caring for children, planning for future financial independence is especially important.
Let's look at several different scenarios.
After divorce, if the spouse paying alimony and/or child support were to die, then the custodial parent may be hard-pressed to maintain the children's current lifestyle, let alone be able to afford college fees. On the other hand, if the custodial parent were to die prematurely, the ex-spouse may find it difficult to cover daily childcare expenses. For these reasons, divorcing couples may want to consider making life insurance policies part of the divorce decree. An example of this language would be as follows: “(Name of husband or wife) shall maintain insurance on (his/her) life in the total amount of ($ amount) as long as (he/she) is required to pay child support. The insurance shall be payable to (Name) as trustee for the minor children. If such insurance is not in force at death, the children shall have a claim against the estate for ($ amount).”
A custodial parent may consider purchasing a life insurance policy on his or her ex. If this is not possible, transferring ownership and beneficiary arrangements on an existing policy may be another option. If policy premiums exceed the budget, the custodial parent may request alimony or child support increases to cover the costs. If the non-custodial parent remains the policy owner, the divorce decree may include arrangements to ensure that the custodial parent is named as the irrevocable beneficiary and receives ongoing proof that the payments continue to be made and the policy remains in effect.
A non-custodial parent may wish to keep the policies he or she already has to protect the financial interests of other family members, such as children from a new marriage.
In this case, the non-custodial parent may consider purchasing a new policy on his or her life with the ex as the owner and beneficiary. If this is done before or during the divorce proceedings, gift tax will not be owed. As part of tax reform, beginning January 1, 2019, alimony or separate maintenance payments are not deductible from the income of the payer spouse, or includable in the income of the receiving spouse, if made under a divorce or separation agreement after December 31, 2018.
For existing policies, it is important that the insurance company be notified of any beneficiary changes: Using a will for this purpose will not be valid. In addition, should the insured remarry and the policy name the “husband” or “wife” of the insured as the beneficiary, the new spouse may receive the proceeds. If the insured does not remarry and this same policy language is in force, then the proceeds may be paid to the secondary beneficiary. If the insured's estate is named as the new bene-ficiary, insurance proceeds will likely be held up in the probate process. If minor children are named as the new beneficiaries, additional problems may arise, as insurance companies generally will not pay minors directly. Consequently, it may be a good idea to create a trust for minor children and name the trust as the beneficiary of the policy proceeds.
Laws vary from state to state, so it is important to consult with financial, tax, and legal professionals. Divorce is rarely easy, but a well–planned strategy can help ensure the short– and long–term financial needs of children.