Life Insurance and Divorce

Divorce complicates everything. That isn’t news to anyone who has ever faced the stress of reconstructing the life of a family, often two, and sometimes three. So it shouldn’t be surprising that divorce has significant ramifications on your life insurance policies and needs.

Case Study 1: Joe and Laura – Treatment of Existing Life Insurance During Divorce

Joe and Laura have three children in their tweens when they get divorced. Joe has existing life insurance in force with Laura as the beneficiary. There are no contingent beneficiaries on the policy. Laura remarries, adopts her new husband’s two children and has an additional child with her new husband.

Scenario A: Life Insurance in Divorce: He Dies First

Joe dies two years later while the life insurance policy is still in force. Laura, as the policy beneficiary, inherits the death benefit. That money is hers, free and clear. She can choose to spend it on living expenses with her new family, buy her new husband a car, send her adopted children to school. She has no obligation to favor her older children – Joe’s children’ in any fashion.

Scenario B: Life Insurance in Divorce: He Leaves the Money to the Kids

When Joe and Laura divorce, Joe realizes that he has minimal interest in looking after Laura and her new family beyond what a court orders. Nevertheless, he is very interested in looking after the welfare of his children. As the owner of his life insurance policy, Joe changes his primary beneficiary designation from his wife to his children. Somewhat sophisticated, Joe meets with a qualified attorney and sets up a very simple trust to act as the beneficiary and to guarantee that the proceeds of the life insurance policy will be safeguarded for the support and well being of his children. Some could be used to assist with their upbringing, some saved for college, and some to help them start their own families. None, however, could be converted to the use of Laura’s new family.

Scenario C: Life Insurance in Divorce: She Dies First

10 years pass since the divorce, and Joe and Laura’s kids are on their own. Laura dies soon thereafter, and Joe dies two years later. When Joe dies, his life insurance death benefit goes to Laura. But, since Laura died first, the money goes to her heir instead – her second husband. The life insurance death benefit is his to do with as he sees fit. He has no obligation to share a penny with Joe’s children. He has become Joe’s primary beneficiary on Joe’s life insurance policy. He uses the money to buy his and hers Harley’s for himself and his new girlfriend. He is very thankful to Joe for leaving him the money.

Scenario D: Life Insurance in Divorce: Saved by the Contingent Beneficiary Designation

Either when he purchased his life insurance policy, or after he read this article on Life Insurance and Divorce, Joe names his children as contingent beneficiaries on his life insurance policy. Now if Laura predeceases Joe, the insurance company will not pay the proceeds to Laura’s estate, it will pay them to Joe’s children. While the contingent beneficiary designation on the life insurance policy doesn’t help in the case where his wife outlives him, its is a simple protection in any case where the ex wife needs to remain as the designated beneficiary.

Case Study 2: Mark and Jill – Court ordered life insurance in a divorce settlement

Mark and Jill have two young children when they get divorced. Joe has no existing life insurance in force. The court orders both alimony and child support. Mark now has a court mandated obligation to provide ongoing financial support for Jill and the kids. The judge will often order Mark to take out a life insurance policy large enough to cover 5 years, 10 years or even 15 years of the ordered support payments. Mark’s attorney is careful to guarantee that the beneficiary and contingent beneficiary designations ordered by the court provide the level of protection for his children that Mark needs. In our experience, policies in divorce decrees are generally structured as term policies with end dates when the youngest child is 21-23 years old.

Case Study 3: Rob Starts a New Family

Rob and Susan have two teenagers when they divorce. Rob remarries a few years later and has twins. Rob is now an older dad and has two very distinct life insurance needs: Rob needs income replacement insurance for his new young family -they are totally dependent on him for the income to survive. But Rob also wants to leave some kind of inheritance for his now grown children. One of the biggest complicating factors is the possibility of resentment or friction between the two families as the older kids worry that their patrimony is being exhausted on dad’s new life.

Rob really needs two different life insurance policies to match the two discrete life insurance needs. First, like the parent of any young family, Rob should determine how much life insurance is needed to cover the income and support needs of his new family. He should then put in place the least expensive term life insurance policy he can afford to cover those dependent children out to adulthood – usually 15 or 20 years. Then, Rob should determine how much permanent life insurance he can reasonably afford to create an inheritance for his older kids. This policy should be a no lapse guaranteed universal life policy so that he can get the largest death benefit at the lowest price without risk of the policy collapsing on itself if interest rates or earning fall below expectations. Since the two policies are likely to be of very different amounts, it isn’t unreasonable for Rob to include his older children as partial beneficiaries under the term policy as well.

Structuring life insurance coverage in a divorce just requires a bit of planning and forethought. The hardest part of the whole process is sitting down with the older children and explaining the coverage structure, and the difference between creating a legacy and guaranteeing money for food. Like everything else in restructuring your life after a divorce, it isn’t easy but it is necessary. And nothing is more important than open communication in keeping relationships wholesome and loving.

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