Today, we are diving into an often overlooked but critical issue: life insurance and divorce
Divorce is never easy. There are many moving parts and lots of decisions that need to be made during negotiations. It is difficult to keep track of everything, and it is very easy to oversimplify some areas of the negotiation process. One of those areas is life insurance in divorce settlements.
There is more than meets the eye when it comes to planning this portion of the divorce.
Generally, life insurance coverage is designed to provide for beneficiaries in the event of someone passing. The goal is to protect the income that will be lost in the event of the death of the insured. So how does that translate to divorce? Since there will be life insurance after the divorce, here are some practical considerations everyone should address:
What are the financial obligations of each partner?
Who receives alimony?
Which type of life insurance coverage is the best?
Term coverage or permanent life insurance?
In divorce, one spouse is often required to pay the other spousal support. The required support may be for life or for a set period of time.
In either case, how will the receiving spouse be compensated if the payee spouse was to pass unexpectedly?
One alternative is to dictate settlement conditions, including alimony and child support payments. This, however, tends to complicate the negotiations and is usually an item of contention. A more expedient alternative is to put in place a life insurance policy on the ex-spouse that will provide the continuation of the spousal support for either a certain time or a lifetime payment.
When a payment is only required for specific period, a term insurance policy will generally work best. It is the least expensive and it is understood that it will go away at the end of the set period.
If a lifetime benefit is required, a permanent policy would make sense in most cases. However, this is more expensive and can affect other settlement conditions in the divorce. Permanent insurance can also be seen as an asset in favor of the beneficiary. In both cases, a determination of who will pay the premiums must be decided early in the negotiations.
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Child Support Insurance
When determining child support, it becomes clear exactly how long the support will be needed. In most cases, support continues until the child reaches the age of majority, which is 18 years of age in most states.
Generally, you will have a specific dollar amount and length of time. This makes it easy to calculate how much insurance would be needed to sustain support payments. The only thing that may come up will be changes in the amount of child support required.
An additional consideration will be the need for college expenses. If spouses are required to provide some level of support, this, too, can be added to the calculation for determining how much insurance will be needed.
When the children are young, it may be difficult to forecast what college expenses will be in the next 10 to 15 years, although there is sufficient data to show the rising cost of college education at numerous institutions. Consideration must be given to using tuition for state sponsored, private, or out-of-state institutions. Costs for all are dramatically different.
If support is required for a special needs child, consideration should be given for establishing a special needs trust. These types of trusts are generally funded through life insurance. Working with an experienced Certified Financial Planner® Professional or estate planning lawyer is advised to determine what would be the appropriate level of insurance needed to support the child.
If there is a pension involved and included in the marital assets, a valuation will need to be conducted to determine the current fair market value of said pension. When the pension assets are already being distributed, it is a much simpler calculation. If the pension will start at some point in the future, the pension valuation becomes important.
The pension valuation will provide a current fair market value that may be provided to the receiving spouse via other assets today with the agreement that they will not receive any portion of the pension later.
However, if the agreement for the receiving spouse is to wait and start receiving the pension later, one must consider the possibility that the spouse providing the pension may pass before retirement. In this case using the fair market value as an amount for life insurance should be considered. This will protect the receiving spouse today and into the future.
In dealing with pensions, both parties should understand how the pension works in the event of death of the employed spouse either prior to retirement or after retirement.
Many pensions provide some level of survivor benefit plans, commonly referred to as SBP. Military and government pensions are pensions that provide the option for SBP.
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Who owns the policy
One often overlooked issue is who should own the policy. It is recommended that the beneficiary should be the owner of the life insurance policy.
The owner has control over payments and beneficiary designations. The premiums will be part of the negotiation determined in the divorce settlement. If the insured is the owner, the beneficiary will have no knowledge as to whether the policy remains in force or if there’s been any change to the beneficiaries.
The beneficiary of the policy would receive the proceeds in the event of death. If minor children are involved, consideration should be given to whether the funds should be put in trust or in the control of the beneficiary.
Who pays for the policy is frequently a contentious item. Keep in mind that the life insurance is for the benefit of the beneficiary and not the insured. The beneficiary may want to consider the premium payments as the price to pay for peace of mind. If term insurance is being used to cover these gaps, it is a small price to pay.
Conclusion: Life Insurance and Divorce
Life insurance in divorce decrees should be detailed. Specific dates should be given for when insured parties are to have the insurance in place and funded. It is recommended the insurance be in place prior to finalizing the divorce.
The beneficiary should request the insured get pre-qualification for the life insurance. This will ensure the person is insurable and at what health level. The pre-qualification will provide a more accurate cost for the insurance.
Don’t leave anything to chance. Consider multiple policies to cover individual needs. You could have a term policy for child support and a permanent policy for lifetime alimony.
Do not attempt this on your own. Hire a Certified Financial Planner® or Certified Divorce Financial Analyst® to assist and support you in your efforts for a fair and equitable solution.
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