Life insurance is not something that most of us like to think about or discuss. However, in the context of divorce it is very important and something that needs to be addressed. While this article talks about life insurance related to divorce, the concepts also apply to unmarried parents or unmarried persons where one may owe money to the other.
The basic idea behind life insurance in a divorce is that if someone owes money to someone else – whether for spousal support, child support or a property settlement – and the person who owes the money (the payor) dies, the person who was relying on that money is out of luck. If the payor has life insurance, the recipient is still provided for.
There are three main considerations in life insurance: How much, how long and beneficiary designation.
How much life insurance is needed?
The amount of life insurance that is needed is usually the amount of money owed to someone. For example, if someone owed a $50,000 property settlement, then $50,000 in life insurance coverage would be needed. One generally accepted exception to this rule is that you don’t necessarily need dollar-for-dollar coverage to insure a spousal support award. The reason for this is that spousal support is taxable to the recipient but life insurance is not. This means, for example, that if someone was supposed to receive $100,000 in life insurance over a period of several years, they would pay taxes on that support and so they really wouldn’t receive $100,000 – they might actually receive $75,000 after paying taxes. In this example, then, $75,000 would be an appropriate amount of life insurance to insure the $100,000 spousal support award. This is only an example which is offered for the purpose of better explaining the concept. You should do your own analysis on how much insurance is appropriate in your particular situation.
When it comes to child support, the easy answer is that you should maintain the same amount as you would pay in child support over time. However, this does not take into account the fact that if one parent passes away the other parent will have substantially increased expenses for increased childcare, now having to pay all of the expenses, etc. For this reason, people will often “round up” and maintain more life insurance to benefit the children than you would otherwise think necessary.
How long do I have to maintain life insurance?
This answer is fairly straightforward – you need to maintain life insurance for as long as you owe money to someone, including any arrearage. An “arrearage” means past-owed money, i.e., payments that you owed but haven’t paid. If you owe back payments, you need to maintain life insurance until you are completely paid up.
Who is the beneficiary?
In spousal support and property settlement situations, the recipient of the money is going to be direct beneficiary of the life insurance. The reason is fairly obvious – if someone was owed money, they should receive the life insurance.
What about for child support?
People sometimes think that their children should be the beneficiary of the parent’s life insurance policy. They shouldn’t! The idea is well-intentioned but a non-starter. Consider this – what if you passed away and your 5-year-old received $250,000 and has a Hot Wheels fascination? Do you get the idea? The money should either go to the other parent to use for the children or should go into a trust for the benefit of the children.
People very frequently name the other parent as the direct beneficiary of life insurance when there are children involved. The basic idea is that the other parent is now responsible for all of the children’s care and expenses and therefore should have access to the money to make necessary purchases.
If someone is not comfortable naming the other parent as direct beneficiary, then the next most common approach is to set up a trust to hold the money. The life insurance policy will name the trust as the beneficiary. The other parent is typically named the trustee of the trust. One benefit of establishing a trust is that there will be specific parameters for using the money. One of the downsides is that the person maintain the insurance has to do some estate planning to make sure this is set up properly. (This isn’t necessarily a bad thing – you should always update your estate plan post-divorce anyways.)
Other considerations. There are a number of other considerations in addition to those mentioned above.
What if it is too expensive?
Sometimes life insurance is cost prohibitive or not available at all. If someone has previously had a serious health issue they may simply not be able to obtain coverage. One way of dealing with this is to have that person leave the other person assets in their estate plan which are sufficient to “pay off” the amount owed to the recipient.
Who pays for the policy?
The generally accepted rule is that it is the responsibility of the person owing the money to maintain and pay for the life insurance. A person who is owed money also has the right to purchase additional coverage on the payor at his or her own cost (i.e., at the cost of the person who is owed the money).
Can I change policies?
A person is typically allowed to change life insurance policies as long as the same amount of coverage is maintained and the beneficiary is notified. A new judgment will need to be obtained which specifies the new policy information.
This article covers the main considerations in life insurance, but it is not exhaustive. You should speak with your mediator or attorney if you have additional questions regarding life insurance in the divorce context. Once you have a signed judgment, the next step will be to submit the judgment to the applicable life insurance company.