Life Insurance: Divorce Settlement Entitlements Explained

Life insurance is often overlooked during divorce proceedings, but it's an important part of the process, especially if children are involved. There are several factors to consider when it comes to life insurance in a divorce settlement. These include updating beneficiaries, accounting for cash value in permanent policies, protecting alimony and child support income, and ensuring that any children involved are financially protected.

Term life insurance is typically considered a separate asset, while the cash value in a permanent policy may be considered joint and subject to division. It's important to review and update life insurance policies to reflect the change in marital status and its implications. This may include removing an ex-spouse as a beneficiary, purchasing additional coverage, or adjusting the policy to protect the financial interests of both parties and their dependent children.

Court-ordered life insurance changes

• Obtaining a new policy: If you don't already have life insurance, the court may order you to purchase a new policy as part of the divorce decree. The type of policy and level of coverage are typically left to the individual to decide, but it should be sufficient to cover alimony and child support obligations.
• Adjusting existing policies: If you already have a life insurance policy, you may need to make adjustments to reflect your new circumstances. This includes reviewing and potentially updating beneficiaries, especially if your spouse was previously listed as the primary beneficiary.
• Cash value considerations: If your life insurance policy has a cash value component, this may be considered a marital asset and subject to division by the court. You may need to include the accumulated cash value in the list of shared assets to be divided.
• Protecting alimony and child support: If you are receiving alimony or child support payments, consider obtaining a life insurance policy on your former spouse. This will protect this income stream in the event of their death.
• Communication and deadlines: When setting up a court-ordered life insurance policy, communicate with your former spouse and respective lawyers about the policy details, including the term length, coverage amount, ownership, and premium payments. Be mindful of any deadlines set by the court for securing the policy.
• Proof of policy: Obtain proof of the policy, such as a signed application or receipt of payment, to provide to the court as required.
• Seek legal guidance: Work closely with your lawyer to ensure you are following the court's guidelines and protecting your interests throughout the process.

Changing beneficiaries

If there are no children involved and you are not required to maintain insurance as part of spousal support, you can change the beneficiary on your policy by contacting the insurance company or your employer's HR department for policies provided through an employer. However, if you are ordered to pay spousal support and/or child support in your divorce settlement, the judge may require you to maintain life insurance with your ex-spouse as the beneficiary to protect these payments. In this case, once your children reach the age of majority, you may file a motion to have the divorce agreement amended.

It's important to note that some life insurance policies have irrevocable beneficiaries, which means that the beneficiary cannot be changed by the policyholder alone. In this case, unless the ex-spouse agrees to changes in the policy, they would remain the beneficiary even after a divorce.

If there are children involved, it is crucial to ensure that they are financially protected. This can be done by maintaining a life insurance policy on your ex-spouse with a benefit amount high enough to replace child support or alimony until the last child is grown. Additionally, as a single parent, it is recommended to take out life insurance on yourself to protect your children's financial future.

To determine the minimum benefit amount, calculate the number of years until your youngest child turns 18 (or 21 for extra safety) and multiply this number by your annual income. This will help ensure that your children are financially protected in the event of your death.

Cashing out permanent life policies

Cashing out a permanent life insurance policy is a way to access money from the policy early. This can be done by withdrawing the cash value, borrowing against the policy, or selling the policy. Here are some things to keep in mind when considering cashing out a permanent life insurance policy:

Understanding Cash Value

The cash value of a permanent life insurance policy refers to the money that accumulates in the policy over time. Each month, a portion of the premium payment goes into a fund that grows with interest. This fund is known as the cash value of the policy and can be accessed by the policyholder at any time.

Withdrawing the Cash Value

Policyholders can withdraw a limited amount of funds from their permanent life insurance policy, usually up to the amount they have paid in premiums. Withdrawals are typically tax-free up to the amount of premiums paid, but exceeding this amount may incur taxes. Withdrawing cash from the policy will reduce the death benefit, so it is important to consider the impact on beneficiaries.

Borrowing Against the Policy

Policyholders can borrow money from their permanent life insurance policy, which is known as a policy loan. This option allows access to "loaned" funds from the overall policy value. However, the loan must be repaid with interest, or the amount will be subtracted from the death benefit. Borrowing against the policy can be risky, as the policy may lapse if the loan amount is not repaid before the policyholder's death.

Surrendering the Policy

Surrendering a permanent life insurance policy means giving up the policy in exchange for a cash payment. The policyholder agrees to settle for the cash surrender value, which is less than the face value of the policy, and the death benefit is forfeited. Surrendering a policy may incur taxes and cancellation fees, and it is important to understand the surrender period to avoid penalties for early cancellation.

Selling the Policy

Policyholders can sell their permanent life insurance policy to a third-party buyer through a life settlement or viatical settlement. A life settlement is typically done by a senior-aged individual in good health, while a viatical settlement is for those diagnosed with a life-threatening illness or chronic condition. The third-party buyer pays a lump sum to the policyholder and becomes the new beneficiary of the death benefit. Selling a policy provides a larger payout than surrendering it but less than the actual death benefit.

When considering cashing out a permanent life insurance policy, it is important to weigh the immediate financial needs against the long-term impact on the death benefit. Consulting a financial advisor can help determine the best option for your specific situation.

Protecting alimony and child support

Understanding Alimony and Child Support:

Alimony, also known as spousal support, is a court-ordered payment from one spouse to another after a divorce. It aims to ensure that the recipient can maintain their standard of living and become financially independent. Child support, on the other hand, is a separate obligation to provide financial support for children's needs, such as food, clothing, and education.

Factors Affecting Alimony Determinations:

Courts consider various factors when determining alimony awards, including the earning capacity, age, education, work experience, physical and emotional condition, and financial situation of both spouses. The length of the marriage and the standard of living during the marriage also play a role in deciding alimony payments.

Protecting Alimony:

To protect alimony payments, it is crucial to consult with an experienced divorce attorney. They can guide you through the specific laws and factors relevant to your state. Additionally, consider the following strategies:

• Prenuptial or postnuptial agreements: These agreements can outline financial arrangements in the event of a divorce, helping to protect your assets and potentially avoiding alimony payments.
• Demonstrate your spouse's ability to earn: If you can prove that your spouse is capable of earning a reasonable living or is cohabiting with someone else, you may be able to reduce or eliminate alimony obligations.
• Fair asset division: Courts often consider the fairness of the divorce settlement when determining alimony. By demonstrating a willingness to split assets equally, you may increase the chances of a favourable ruling regarding alimony.
• Choose the right attorney: Selecting a knowledgeable divorce attorney who specialises in spousal support can significantly enhance your chances of avoiding or reducing alimony payments.

Protecting Child Support:

Child support is typically calculated based on specific guidelines and factors, including the income of both parents and the needs of the children. Here are some ways to protect child support payments:

• Life insurance policies: Consider maintaining a life insurance policy on your ex-spouse to safeguard against the loss of child support income in the event of their death. The benefit amount should be sufficient to replace child support until the children become adults.
• Ownership of the policy: To ensure continuity of payments, the recipient of child support (usually the custodial parent) may want to own the life insurance policy. This provides control over payments and beneficiary designations.
• Third-party authorisations: Adding third-party authorisations to the life insurance policy allows for direct notification from the insurance company about any changes, such as beneficiary updates or policy lapses. This helps ensure the policy remains active and safeguards support payments.
• Reallocation of support: Financial circumstances can change after a divorce. If the paying spouse loses their job or the receiving spouse's income increases significantly, a reallocation of support and corresponding adjustments to life insurance obligations may be necessary.
• Stepping down insurance: As support payments are made over time, the paying spouse may be able to reduce their life insurance coverage or add a new beneficiary to receive a portion of the death benefit. However, this adjustment must be made by the policyholder.

Keeping a policy on an ex-spouse

During divorce proceedings, the court may require one spouse to maintain life insurance for a certain amount of time, with their ex-spouse listed as the beneficiary. This is called "court-ordered life insurance". While this doesn't require you to take out a policy on your ex-spouse, it serves the same purpose of securing alimony and child support payments.

If you choose to take out a life insurance policy on your ex-spouse, you will need their consent and they will likely need to sign the application or an affidavit. The cost of the policy will depend on factors such as the type of life insurance, the amount of coverage, and your ex-spouse's health, age, and lifestyle.

It's important to note that, in most states, an ex-spouse is no longer considered to have an insurable interest. However, a divorce agreement may mandate that an ex-spouse takes out life insurance coverage, especially if there are children involved.

In summary, keeping a life insurance policy on an ex-spouse can be a way to protect your financial interests, especially if you are receiving alimony or child support. However, it requires proving financial dependence on your ex-spouse and obtaining their consent for the policy.

Frequently asked questions