Sometimes, life just turns out differently than expected. No matter how well we think it through, no plan is ever 100% foolproof. Divorce is messy. It is tedious, and time consuming, and in the worst cases, it can be bitter. But like anything else, there is a process to it. Overall assets need to be accounted for and negotiations take place, ultimately with the goal that it be as clean a break as possible. And while most people are aware that they will be negotiating financial assets, we often forget that Life Insurance is in fact an asset. Let’s review a few important facts as to how different types of Life Insurance are treated in divorce proceedings.
Term Life vs. Whole Life
According to LexisNexis (LN), in common law states, term life insurance policies are generally treated as separate property, no matter when they are acquired. However, whole life insurance policies are generally marital property, and the cash surrender value is subject to equitable distribution.
The reasoning here is straightforward. A term life policy has a specific timeframe in which you pay premiums, but the policy ends at a set date, at which point, you replace your policy. A whole life policy however matures as a financial asset, and should you live to the end of the policy when it is fully mature, you get the cash value (although this is generally at the policy anniversary closest to age 100). However, a whole life policy can be cashed out before death, based on the cash value of the policy and not the actual benefit amount.
Additionally, they (LN) also added “In community property states, the time of acquisition and the source of the funds used to pay the premiums usually determine the nature of the property. If the policy was acquired prior to the marriage and with separate funds, the policy is generally separate property. However, if the policy was acquired after the marriage and/or the premiums were paid with community funds, the policy is generally deemed community property.”
Take the Time to Plan it Out
Just because a marriage is over does not mean there are no beneficiaries. This is obvious in the case of children, but every relationship is different, and some divorces are even friendly! So, don’t fall into the trap of overlooking something this important. Here are a few tips just in case you ever need them.
- Determine how much coverage you will need. This is particularly important, as you should examine what your former partner’s situation would be if alimony or child support ended. Remember, child support is for the day to day wellbeing.
- Discuss the duration of coverage
- Decide who will pay the premiums. This one may seem a bit confusing, but if a policy is meant to supplement alimony or child care in the event of your death, then it stands to reason you would be paying it anyways. Splitting the cost of the premium would be a cost effective way of handling this.
- Re-designate beneficiaries. Depending on the divorce settlement, many couples will re-designate the beneficiaries of their life insurance from their ex-spouse to their children or create a trust to handle the proceeds of a death benefit. In some states, probate laws automatically disqualify a former spouse from receiving life insurance proceeds unless the insured re-designates their ex-spouse after the divorce. If the children are minors, consider appointing an adult custodian or trust to receive and handle the benefits on their behalf. Be sure to specify when the money will be transferred to the children and the percentage each child is to receive. Also keep in mind that your beneficiaries cannot be re-designated after your death, so keep it updated.
- It must be said; some people are financially irresponsible. If you have children and have them designated as beneficiaries, it would be wise to set up a revocable living trust and name it as the beneficiary, so that you can ensure that the money is being spent wisely
As so frequently happens, when people go through a major life change, and we tend to “shake it up” and try to rebuild. Usually this makes sense, but in some cases, it’s important to maintain and even build upon the foundation you have set, and life insurance is no different. Keep in mind that life insurance is a service that will only get more expensive when you start over. This is something everyone should keep in mind. Keep the policy active.
Planning for What Comes Next
Changes in life are almost never easy, and a divorce is one of the more difficult changes to adapt to. But a change in a relationship does not necessarily mean a change in responsibilities. Ultimately, the smart move is to make sure you are in a position that you will fulfill your obligations. And even if relationships don’t work out, it is always a good thing to be someone your loved ones could rely on.