Divorce And Life Insurance: What Happens To Your Policy?

Life insurance is often overlooked during divorce proceedings, but it's an important part of the process, especially when children are involved. A divorce settlement may require one or both spouses to purchase and maintain a life insurance policy, especially if one spouse is required to pay alimony or child support. In such cases, the paying spouse may be mandated to list the receiving spouse as the primary beneficiary.

Divorcees should consult their attorney before making changes to their life insurance policy. They may also need to provide documentation of their current insurance policies, assets, and liabilities. If the divorce settlement requires one spouse to maintain a life insurance policy, the agreement should clarify who will pay the premiums.

If a life insurance policy has a cash value component, this may be considered a marital asset and divided between the former spouses.

Changing beneficiaries

Changing the beneficiary of a life insurance policy is one of the most important steps to take when going through a divorce. Here are some key points to consider regarding beneficiary changes:

Review and Update Beneficiaries

The first step in the process is to review the beneficiaries listed on your life insurance policy. Most married couples have their spouse as the primary beneficiary, but after a divorce, you may want to remove your ex-spouse and designate a new beneficiary. This can be done by contacting your insurance company or employer's HR department for policies provided through an employer. However, it's important to consult a divorce lawyer before making any changes, as there may be legal implications, especially if you have children or ongoing financial obligations to your ex-spouse.

Impact of Divorce on Beneficiaries

The impact of divorce on life insurance beneficiaries depends on several factors. If there are children involved and your ex-spouse has custody or you share custody, you may want to keep your ex-spouse as the beneficiary to ensure your children's financial protection. Additionally, if you owe alimony or child support, the court may require you to maintain your ex-spouse as the beneficiary. In some states, the divorce laws automatically revoke the beneficiary status of an ex-spouse, necessitating the designation of a new beneficiary.

Choosing a New Beneficiary

When choosing a new beneficiary, you have several options. This could be a new partner or spouse, your adult children, a trust, other family members or friends, or even a charity. If you have minor children, you may want to list them as beneficiaries. However, it's important to consider the complications that may arise if they are still minors, as most states require beneficiaries to be 18 or older to receive a life insurance death benefit. To address this, you can designate a custodian or create a life insurance trust to manage the insurance payouts on behalf of your minor children.

Irrevocable Beneficiaries

It's important to note that some life insurance policies have irrevocable beneficiaries, which means the policyholder cannot change the beneficiary without their consent. In such cases, the ex-spouse, as an irrevocable beneficiary, would have the right to the payout upon the policyholder's death, even after a divorce, unless they agree to changes in the policy.

Life Insurance and Marital Assets

Life insurance policies, especially whole life and universal life policies, may be considered marital assets during a divorce, particularly if they have accumulated cash value. This means that the policy's cash value may need to be divided between the spouses as part of the separation agreement. Term life insurance policies, on the other hand, typically do not have cash value and are generally not treated as marital assets.

Cashing out permanent life policies

Cashing out a permanent life insurance policy is a complex process that requires careful consideration of various factors. Here are some key points to keep in mind:

Understanding Permanent Life Insurance

Permanent life insurance, such as whole life or universal life insurance, offers a "cash value" component that accumulates over time. This means that a portion of your premium payments is set aside by the insurance company, earning interest and growing in value. This cash value is accessible to you while you are alive and can be a valuable financial asset.

Options for Cashing Out

You have several options for cashing out the cash value of your permanent life insurance policy:

• Full Withdrawal: You can withdraw the entire cash value of your policy, but this will likely result in surrender charges and income taxes. It will also require you to surrender your policy, meaning your coverage will end, and your beneficiaries will no longer receive a death benefit.
• Partial Withdrawal: Taking out a partial withdrawal allows you to access some of the cash value while maintaining your policy. However, your beneficiaries will receive a smaller death benefit, and there may be tax implications.
• Borrowing: You can borrow money from the insurance company, using your policy's cash value as collateral. This option usually has lower interest rates compared to personal or home equity loans, and there is no loan application or credit check. However, any unpaid balance, including interest, will reduce your benefits.
• Surrender: Surrendering your policy means cancelling it and receiving the surrender value in cash. This option comes with surrender fees and results in the loss of coverage and death benefits for your beneficiaries.
• Selling: You can sell your policy to a life settlement company, receiving a lump sum payment that is greater than the cash value but less than the death benefit. The buyer will then take over premium payments, and upon your death, they will collect the death benefit. This option may have tax implications and disqualify you from certain programs.

Important Considerations

When deciding whether to cash out your permanent life insurance policy, consider the following:

• Financial Need: Evaluate your financial situation and determine if you have adequate assets to support your dependents if you pass away. Cashing out may leave them with a reduced death benefit or none at all.
• Tax Implications: Withdrawals, surrenders, and sales of your policy may have tax consequences, especially if the amount exceeds your total premiums paid.
• Beneficiary Impact: Cashing out will likely reduce the death benefit for your beneficiaries. Consider their financial needs and how this decision may affect them.
• Alternative Options: Explore alternative ways to access funds, such as loans, personal loans, home equity loans, or borrowing from your retirement accounts.
• Policy Requirements: Review the terms and conditions of your policy to understand any specific requirements, restrictions, or penalties associated with cashing out.

Protecting alimony and child support

Include Life Insurance in the Divorce Settlement

Incorporate life insurance as part of the divorce settlement. This involves purchasing your own life insurance policy, especially if you are the primary caretaker and monetary provider for your children. Term life insurance is a suitable option if you seek coverage until your child becomes financially independent, while whole life insurance offers permanent coverage but at a higher cost.

Set Up the Policy Correctly

Ensure that your children are the primary beneficiaries of the policy and will have access to the benefit. You can also name a living trust as the beneficiary to manage the funds on their behalf. It's crucial to set up the policy correctly so that your children's financial security is prioritized.

Get Coverage for Your Ex-Spouse

It is equally important for your ex-spouse to have life insurance if they are paying alimony or child support. They can take out a life insurance policy themselves, with you and your children as beneficiaries. Alternatively, you can purchase life insurance for your ex-spouse, but their consent is required, and you must prove that you are financially dependent on their support.

Choose the Right Policy

There is no one-size-fits-all life insurance policy for single parents. The best policy depends on your unique needs and preferences. Consider whether term life or whole life insurance aligns better with your circumstances and future goals.

Calculate the Required Coverage

To determine the necessary coverage amount, assess your financial obligations, including alimony, child support, and other debts. Multiply the total annual support amount by the number of years you are expected to make payments. This calculation will give you an estimate of the coverage needed to secure your children's financial future.

Consult Professionals

Before finalizing any decisions, consult financial advisors and legal professionals. They can provide guidance to ensure your life insurance choices comply with court orders, divorce agreements, and any applicable laws.

Updating policies post-divorce

Divorce is a difficult time, and there are many things to consider, from the emotional impact to the practical. One thing that shouldn't be forgotten is your insurance policies. Here are some steps to help you update your insurance policies after a divorce:

• Auto insurance: If you and your ex-spouse shared a policy, you will need to decide whether to continue on the same policy or get separate policies. If you remain living together, you can stay on the same policy, which may be beneficial for multi-car discounts. However, if you live at different addresses, you will need separate policies. If you have children with driving licenses, they will need to be listed on both parents' policies but only rated on one.
• Home insurance: Contact your home insurance provider to update your policy to reflect the change in living arrangements. If one spouse is moving out, you will need to remove them from the policy and update the name on the policy. You will also need to inform your insurer about any changes in ownership of possessions and personal property. The spouse moving out will need to obtain a new policy for their new residence.
• Life insurance: Many couples list their spouse as the primary beneficiary of their life insurance policy. After a divorce, you may want to change this, but parents with joint custody may want to keep their ex as the primary beneficiary to provide finances for childcare. If there are children involved, both parents should keep life insurance with the other as the beneficiary to ensure financial support for their children if one parent dies. If there are no children, there is little reason to keep an ex-spouse as a beneficiary. If your policy has a cash value, you can either divide this with your ex-spouse or cash it out and use the money differently.

In addition to updating your insurance policies, there are several other steps you should take to ensure your finances are in order post-divorce. These include:

• Reviewing your divorce decree and closing any joint accounts
• Updating your will and estate plan
• Updating your tax information
• Meeting with a financial advisor to review your financial situation and set new goals

Common problems with divorce and life insurance

Divorce and all the things that come with it can be overwhelming. Even in the most amicable of splits, there are finances to figure out, belongings to split, and—if there are children—custody agreements to make. It's no surprise then that life insurance can become an afterthought. However, it's important to handle existing life insurance policies during a divorce, especially if there are children involved.

Beneficiary Disputes

One of the most common issues is disagreements over who should be the policy's beneficiary, especially if children are involved. Changes to beneficiaries after divorce require careful consideration to ensure they comply with legal mandates and reflect the intentions of both parties.

Policy Ownership Conflicts

Determining who gets to keep the life insurance after divorce or how to divide it can become a contentious issue for joint policies.

Missed Premium Payments

During the upheaval of divorce, it's easy to overlook premium payments, leading to a policy lapse and loss of coverage. Maintaining payment schedules is crucial to avoid such pitfalls.

Overlooking Cash Value

In policies like whole or universal life insurance, the cash value is often forgotten or underestimated during asset division.

Failure to Update Policies

Many people forget to update their life insurance policies post-divorce, leading to unintended beneficiaries.

Tax Implications

If you cash out a life insurance policy with a significant cash value, the amount exceeding your total premiums could be considered taxable income. Similarly, dividing a joint policy's cash value during a divorce may incur taxes for both parties. Consulting a tax advisor can provide personalized guidance.

Legal Costs

Divorce and life insurance conflicts can lead to legal battles, adding financial strain and emotional stress.

Being aware of these common problems can help you proactively address and mitigate complications, ensuring your financial strategy remains solid throughout and beyond the divorce process.

Frequently asked questions