How Life Insurance Works in Divorce
Life insurance sometimes has value as an asset for division during divorce. The type of life insurance determines whether or not there is a value that should be divided.
Most life insurance policies, but not all, are term life insurance policies. This is the type of group life insurance that employers offer as part of the company benefit package. These policies only exist for a certain term or certain number of years. If the employee no longer works at the company, the policy terminates and is not converted to a different policy that can continue the term.
Many who purchase individual life insurance policies purchase term insurance because the premiums are generally less than whole life or universal life insurance. These are simpler and less expensive policies than whole life or universal life policies. This is due to many reasons, but one of the reasons is because term life insurance has no value until the policy pays out, and this payout is on the death of the insured. If the insured does not pass away before the termination of the policy, the policy expires and there is no value.
Whole life insurance policies, on the other hand, have cash values. While there are many varieties of whole life policies, they do not have an expiration term—they last for your entire life. The cash value portion is the value that is built up through the years of paying premiums and you can borrow against or sell the policy and the cash value is returned to the owner of the policy. Thus, there is a value associated with the policy and this is what may be divided in divorce if marital funds were typically used to pay for the premiums.
The first step in divorce is to determine whether any life insurance policies are whole life or universal life policies (which also build up a cash value). To determine the cash value, it is not the payment on death but rather whatever the statement shows as built up value less the surrender charge (fees) to cash in on the value. This is the value of the policy that should be divided if purchased with marital funds.
To avoid a surrender charge or a reduction in the death benefit ultimately payable, life insurance with cash value is awarded to the policy owner (or the owner is changed to the person receiving support) and the amount of the cash value is offset with another asset. This allows the policy to remain intact and all of the benefits to remain in place.
How is this executed? One-half the cash value is transferred deducted from the spouse retaining the policy from that person’s share of another asset. The asset may be cash in a savings or checking account, brokerage equities or bonds, net proceeds from the sale of the house, or other assets. This will equalize the award of the life insurance with cash value to one of the spouses without requiring the parties to pay the surrender charge which would reduce the amount of the net proceeds paid from the cash value, or to affect the benefits of the policy. It is often the simplest way to account for the cash value in a policy.
Life insurance is also used in divorce as security for future unpaid child or spousal support payments in the event the payor passes away. If there are ongoing support obligations then life insurance and disability insurance are instruments used to protect the payee(s) and to ensure that they will still receive support if the payor passes.
Courts do not usually order that estates continue to pay the support obligations. If the parties settle out of court through mediation, this may be an alternative, but there would also need to be ongoing monitoring of the estate plan to ensure that it is not rewritten post-divorce to other terms.
How much of the life insurance gets assigned to the support obligation is contingent upon the remaining outstanding payments in the divorce. The Marital Settlement Agreement may be written to state a declining percentage of the full amount of the policy is available to cover the outstanding child support and/or spousal support obligation. This allows multiple beneficiaries to be named on the policy, but still maintaining coverage for the amount of any remaining support obligation. Alternatively, the policy owner may want to reduce the coverage in subsequent years as the support obligation reduces, if the policy is strictly in place only for support purposes. Of course, this reduction plan should be specified in the Marital Settlement Agreement.
The amounts may not be amortized but rather written broadly to reduce in increments of 5 years or so in order to reserve the remainder for another beneficiary if desired. Oftentimes, the obligation for the premium payment is on the insured, but the owner of the policy may be the supported party. This arrangement would need to be specified in the Marital Settlement Agreement. It allows for the verification that the premiums are still being paid to maintain the policy for the benefit of the supported individuals. Often this verification is at least annually in which the beneficiary designations are sent to the supported party.
Sometimes, to ensure that the premiums are paid, the supported party takes responsibility for the payments. This is security for future payments in the event of death of the payor. It does impose a cost on the supported party, but with assurance that the policy will remain intact.
Reassurance that there will be needed support in future years is important to many who receive child and/or spousal support. Maintaining life insurance, whether it is whole, universal or term life is a way to obtain that sense of security.
Note: This article is for informational purposes only and is not intended to provide either tax or legal advice. Please contact your attorney or accountant and rely on their independent research and advice for these matters
