Insurance Issues That Concern
Divorcing Couples
What effect does divorce have on
life insurance?
Like most of your financial planning
objectives, your life insurance needs are related to the circumstances of your
life. As your life goes through changes, your life insurance often needs to
change with it.
No life change may be of more consequence
than a divorce. In addition to the financial and emotional difficulties that
often accompany divorce, there are special concerns about your life insurance.
Generally, one spouse is the beneficiary of the other's insurance, and vice
versa. So you have to think about whether to change your beneficiary and whom
your new one will be. You also have to consider whether a new designation will
have tax consequences. One thing is certain: A divorce will have an effect on
your life insurance needs, and your policy must be updated to reflect them. Not
all life insurance policies are just for death protection. You may have cash
value policies such as whole life, universal life, variable universal life, or
variable life that you've used to save for your children's college education or
as a supplement to retirement. Divorce may not directly affect the savings side
of your life insurance. Keep in mind, however, that the cash value of any
savings may be considered part of the marital assets.
New and continuing needs for life
insurance
In general
Early planning is essential for evaluating
your new and continuing needs for life insurance. Your planning should begin
long before the divorce is final. If you have children, protecting them will be
one of your first concerns.
If you don't have children, protecting
alimony payments that you are receiving may be on the top of your list. Life
insurance could prove to be a beneficial protection. Your needs will differ
depending on your post-divorce point of view. The parent who is responsible for
the children (custodial parent) has different concerns than the parent who is
not (the noncustodial parent). If you are a custodial parent, you should make
sure that the life of the noncustodial parent is insured. You don't want to be
in a position where the child support payments suddenly end because of the
death of the parent responsible for paying them. The same thing applies to
alimony payments. Life insurance can protect you and your children in case of the
other parent's untimely death. If you are the noncustodial parent, you should
insure the life of your custodial counterpart. If the other parent were to die,
you would most likely gain custody of the children. This will increase your
expenses dramatically, especially when multiple children are involved. Life
insurance coverage can be used to help you protect your children's future.
Protecting yourself as the former
spouse who has no insurance
Purchase a
new policy on the life of your former spouse
Going out and purchasing a life insurance
policy on your former spouse is the easiest way to protect yourself. You may
not be able to afford it, however, or the other spouse may not be willing to go
through the necessary physical examination and blood tests. The insurance
company also has to agree that there is an insurable interest between former
spouses.
Have existing
policies transferred to you
If your former spouse has an existing policy
on his or her life, it can be transferred to you as the policyowner and
beneficiary for the protection of your alimony/child support payments. This can
be planned as part of the divorce agreement. It's also a good option when you
can't obtain new insurance on your former spouse.
Tip: Including this in a divorce agreement is generally a good idea
with respect to gift tax planning. Generally, if a husband and a wife enter
into an agreement covering their property rights and divorce occurs within a
specified period, all transfers of property under the agreement are considered
made for full consideration and, therefore, are not subject to gift tax.
Have
alimony/child support payments increased to cover the cost of additional
insurance
If you receive alimony payments, you can seek
an increase in the amount of alimony paid by your former spouse by the amount
necessary to insure his or her life. The insurance likely cannot be issued
unless your former spouse agrees to be insured.
Caution: The downside is that when you receive alimony payments, they are
included as taxable income to you and can end if you remarry or die.
If you receive child support payments, you
can similarly seek to have them increased to cover the cost of life insurance.
From the custodial parent's point of view, it's better to have the payments
categorized as child support because they are not included as income to the
custodial parent. The decision as to whether the payments are alimony or child
support has to be worked out between you and your former spouse. This can, and
should, be planned for in the divorce agreement.
Protecting your children as the
parent who has insurance
Have the
insurance proceeds paid to your child
Using the proceeds of your life insurance
policy to protect your children is an obvious and practical planning choice.
What's not so obvious is how to use your existing policy in a way that is most
beneficial to you and your child.
Purchase a
policy on your life for the custodial parent
If you are the noncustodial parent, a second
option is to purchase a new policy on your life for the custodial parent. This
way you can keep any policies you currently have and protect your children's
future at the same time.
Tip: The benefit of this choice is that the policy can be given to your
spouse free from gift tax if given either before or as part of the divorce
agreement.
Tip: If the policy is entirely in your former spouse's name and you
have no incidents of ownership with respect to the policy (i.e., you don't
retain any control of the policy in the event of contingencies, such as death
or remarriage), you can pay the premiums on the policy and the premiums will
likely be considered alimony and deductible for income tax purposes. The court
decides many of these alimony/child support issues.
Caution: If you purchase a new policy for your former spouse, you won't be
able to control who is designated beneficiary. Other options may provide you
with more control.
Beneficiary designation issues
In general
If you have a policy that designates your
former spouse as beneficiary, the first thing you will probably want to do is
change the designation. Before you do, there are beneficiary designation issues
to consider.
Generally, the divorce itself will not remove
your former spouse as the beneficiary, so you need to take action if you wish
to change the beneficiary. If a court has ordered you to maintain an existing
policy in favor of your former spouse, you cannot change it. Changing the
beneficiary is usually as easy as calling up the insurer and requesting the
appropriate paperwork. Occasionally, a physical endorsement will also be
required.
Who to
designate as beneficiary
You can generally designate any person or
entity to be the beneficiary of your life insurance proceeds. The choice,
however, typically boils down to either designating your estate or your
children.
Caution: Designating your estate as beneficiary may tie up the insurance
proceeds in probate and may cause the insurance to be subject to estate taxes.
If you have children, it's a good idea for
you to designate them as your beneficiaries. This may not be as simple as it
seems, however. There are many different ways to go about it, and each has
various benefits and drawbacks. Four options are illustrated in the following
table:
Children As
Beneficiaries of Life Insurance--The Options
CornerStone Financial
Whether your
nest-egg is worth millions or thousands,
You and your
family deserve it more than the government....
We are here to help you with all of your
financial and insurance needs. Our skilled professionals are licensed with
over 100 top name companies and can help you gain a better understanding of the
concepts behind insurance including investing, retirement and estate
planning. There are literally thousands of products to choose from,
but we can help pinpoint what is best for you and your situation. Please
do not hesitate to contact us if you have questions.
Contact:
Eric Tuttobene
President/CEO
CornerStone
Financial
(615) 427-8780
IMPORTANT DISCLOSURES
The
information presented here is not specific to any individual's personal
circumstances.
To the extent
that this material concerns tax matters, it is not intended or written to be
used, and cannot be used, by a taxpayer for the purpose of avoiding penalties
that may be imposed by law. Each taxpayer should seek independent advice from a
tax professional based on his or her individual circumstances.
These
materials are provided for general information and educational purposes based
upon publicly available information from sources believed to be reliable—we
cannot assure the accuracy or completeness of these materials. The information
in these materials may change at any time and without notice.
