Life Insurance And Divorce: What You Need To Know

Life insurance is often overlooked during divorce proceedings, but it is an important consideration. Divorce will not automatically invalidate or adjust your life insurance policy; any changes will need to be made by the policyholder. Depending on the type of policy, it may be considered a marital asset and therefore subject to division. Term life insurance policies are usually shielded from the divorce process, whereas whole life insurance policies are often considered a joint asset due to their cash value.

If you have children, you may want to keep your ex-spouse as the beneficiary of your life insurance policy to ensure your children will be financially supported in the event of your death. However, if there are no children involved, there is little reason to keep your ex-spouse as the beneficiary, especially if the divorce was acrimonious.

In some cases, a court may order an individual to purchase life insurance as part of a divorce settlement, particularly if they are required to pay alimony or child support.

Court-ordered life insurance

The court may require either spouse, or a third party, to own the policy and be named as the beneficiary. In contentious circumstances, the policy owner may stop paying premiums or change the beneficiary without notifying the other spouse, so it is important to have a cooperative relationship or involve a third party such as a custodian or trust. The court may also enforce the beneficiary status of the receiving spouse, meaning the policy cannot be changed without their authorisation.

To obtain court-ordered life insurance, one must review policy requirements, designate beneficiaries as specified by the court, and consider the purchase timeline as there is usually a deadline by which proof of the policy must be demonstrated. The process can be lengthy, so it is important to start well in advance.

Changing beneficiaries

Review and Update Beneficiaries

It is common for married couples to list their spouse as the primary beneficiary on their life insurance policy. After a divorce, you will likely want to change this, especially if the divorce was acrimonious. Contact your insurance provider to understand the process for changing beneficiaries. Most policies are revocable, meaning you can change the beneficiary at any time. However, some policies have irrevocable beneficiaries, which cannot be changed without the beneficiary's consent.

Consider the Impact on Children

If you have children, you may want to set up a trust and name the trust as the beneficiary of your policy. This ensures that the proceeds from the policy are managed by a trustee and used for the benefit of your children. Alternatively, you can name a custodian or guardian to control the funds on behalf of your children.

Alimony and Child Support

If you are receiving alimony or child support payments from your ex-spouse, you should consider maintaining a life insurance policy on them. This will provide financial protection in the event that your ex-spouse passes away before their payment obligations are complete.

Communicate with Your Ex-Spouse

If you and your ex-spouse share custody and financial responsibility for your children, you may want to keep them as the beneficiary of your policy. This is a simple solution that ensures your children will be financially provided for in the event of your death.

Seek Legal Advice

The laws regarding life insurance and divorce vary by state, and it is important to understand your rights and obligations. Consult with a divorce lawyer to understand how life insurance should be addressed in your specific situation.

Cashing out permanent life insurance

Understanding Permanent Life Insurance:

Firstly, it's important to understand the nature of permanent life insurance. Permanent life insurance, as the name suggests, provides coverage for your entire life, unlike term life insurance, which is limited to a specific period. Permanent life insurance also has a cash value component, which grows over time and can be accessed in several ways.

Four Ways to Access Cash Value:

There are four primary methods to access the cash value in a permanent life insurance policy:

• Surrender: You can cancel the policy and receive the surrender value in cash. However, this option leaves you without life insurance coverage, and the cash received may be reduced by surrender fees, especially for newer policies.
• Withdrawal: You can withdraw cash from your permanent life policy, often without income taxes if the amount withdrawn is less than or equal to the total premiums paid. However, this may reduce your death benefit, and there could be tax consequences depending on the policy's specific terms.
• Loans: You can borrow money through your policy, with the insurer using your policy as collateral. These loans typically have lower interest rates than personal loans, and there is no loan application or credit check required. However, the outstanding loan balance will be deducted from your death benefit if you choose not to repay it.
• Use Cash Value to Pay Premiums: You can use the cash value to pay your life insurance premiums, making it easier to maintain coverage, especially for older policyholders who want to use retirement income for living expenses.

Tax Implications:

When cashing out permanent life insurance, it's essential to consider the tax implications. Withdrawing up to the total premiums paid into the policy is generally not taxable. However, withdrawing any gains or dividends may be taxed as ordinary income. Additionally, there may be taxes and fees associated with surrendering the policy, which can significantly reduce the cash value.

Impact on Death Benefit:

It's important to note that accessing the cash value of your permanent life insurance policy will likely reduce your death benefit. The reduction may be greater than the amount withdrawn, depending on the specific terms of your policy. Therefore, carefully review the policy or consult with your agent to understand the impact of withdrawing money.

Alternative Options:

Before cashing out your permanent life insurance, consider exploring alternative options, such as borrowing against your 401(k) plan, taking out a home equity loan, or selling your insurance policy if allowed. These options may provide liquidity without compromising your life insurance coverage.

Timing Considerations:

It is generally recommended to wait at least 10 to 15 years before cashing out your permanent life insurance policy to allow the cash value to grow. Consult with a financial professional or insurance agent to make an informed decision that aligns with your specific circumstances.

Protecting child support

Life insurance is an important aspect of divorce agreements, as it ensures financial protection for both ex-spouses and any dependent children. Here are some key considerations for protecting child support payments through life insurance:

• Court-ordered life insurance: In many divorce cases, the court may order one or both parties to purchase a life insurance policy, especially if there are minor children or alimony involved. This ensures financial protection for the ex-spouse and children who depend on the higher-earning spouse's support.
• Determining the policy type and coverage: The specific type of life insurance (e.g., whole life or term life) and the amount of coverage needed will depend on factors such as the duration of child support obligations and the income of the paying spouse. It's important to consult with a financial professional to determine the appropriate coverage.
• Naming beneficiaries: If you have minor children, consider creating a trust to manage the distribution of policy proceeds among them. Alternatively, you may designate your ex-spouse as the beneficiary if they have custody of the children and the split is amicable.
• Protecting child support payments: To ensure continued child support in the event of the paying parent's death, consider securing these payments with a life insurance policy. This can be done by requiring the paying spouse to maintain a policy with a benefit amount sufficient to replace child support until the children reach adulthood.
• Ownership of the policy: One way to prevent the paying spouse from unilaterally changing beneficiaries or coverage is to have the receiving spouse or a trust own the policy. This gives the recipient control over the policy and ensures that it aligns with the children's best interests.
• Regular proof of insurance coverage: To prevent unexpected changes to the life insurance policy, the divorce agreement should include a provision requiring the paying spouse to provide yearly proof of insurance coverage, including policy details and beneficiary designations.
• Addressing support obligations: The insurance provision in the separation agreement should clearly state the financial obligations of the paying spouse, including any child support or alimony payments. It should also outline the consequences of failing to meet these obligations, such as bringing a claim against their estate.
• Consideration of other financial circumstances: It's important to review and adjust life insurance policies periodically, especially if there are significant changes in income or financial circumstances for either spouse. This may result in a reallocation of support and insurance obligations.
• Seeking legal and financial advice: Consult with a knowledgeable insurance professional or financial planner to navigate the complexities of life insurance during a divorce. Additionally, an experienced family law attorney can provide guidance and draft a comprehensive settlement agreement that protects your interests and those of your children.

Common life insurance problems

Divorce is a complex process that can lead to various life insurance issues. Here are some common problems that individuals may face during and after a divorce:

• Beneficiary disputes: One of the most common issues is disagreements over who should be the beneficiary of a policy, especially when children are involved. It is essential to carefully consider beneficiary changes to ensure they comply with legal mandates and the intentions of both parties.
• Policy ownership conflicts: Determining who retains ownership of a life insurance policy after a divorce can be challenging, especially for joint policies.
• Missed premium payments: During the upheaval of a divorce, it is easy to overlook premium payments, leading to a policy lapse and loss of coverage. Maintaining timely payments is crucial to avoid such pitfalls.
• Overlooking cash value: In policies like whole or universal life insurance, the cash value component is often forgotten or underestimated during asset division. It is important to account for this value as it can be a significant asset.
• Failure to update policies: Many individuals forget to update their life insurance policies after a divorce, which can lead to unintended beneficiaries remaining on the policy.
• Tax implications: Cashing out a life insurance policy with a significant cash value may result in taxable income. Additionally, dividing the cash value of a joint policy during a divorce may incur taxes for both parties. It is essential to consult a tax advisor for personalised guidance.
• Legal costs: Disputes over life insurance during a divorce can lead to legal battles, adding financial strain and emotional stress to an already difficult situation.

Being aware of these common problems can help individuals proactively address and mitigate potential complications, ensuring their financial strategy remains solid during and after the divorce process.

Frequently asked questions