Many Americans have chosen to help provide for their family’s needs aﬁer their death by purchasing a life insurance policy. As part of careful estate planning, having life insurance can provide your family with the ﬁnancial support they need after your death to meet living expenses, college tuition, medical care, or other necessities.
This is no less important a concern when a couple divorces. However, the type of policy, its cost and who is named beneﬁciary may require some additional consideration.
Generally, life insurance policies fall under one of the following categories:
- Term life insurance
- Whole life insurance
- Universal life insurance
Term life gives the policy holder the ﬂexibility to obtain only the coverage they need by choosing the amount of time that the policy lasts, typically 5 to 30 years. Once the term ends, the policy expires. If the insured dies during that time, a death beneﬁt is paid to the policy’s beneﬁciary. As the most affordable type of life insurance, the premiums are typically lower (depending on your individual factors), but must be paid regularly to keep the policy active.
Whole life provides coverage for your entire life. The policy holder’s premiums and death beneﬁt will remain the same throughout their lifetime. Whole life insurance accumulates cash value tax-deferred, giving the policy holder a guaranteed return on their investment. Some families purchase a whole life policy at an early age, with the idea that the cash value being built up in the policy will be used to help fund college costs of their children down the road. However, while the stability and certainty of a whole life insurance policy is attractive, it is also the most expensive option for life insurance coverage.
The coverage on a universal life insurance policy lasts for your entire lifetime and accumulates cash value tax-deferred as you pay your premiums. Part of the money is put into a cash account to accumulate interest, while the other part is paid into your policy. A signiﬁcant beneﬁt of universal life insurance is that unlike other policies, the policy holder can stop paying their premiums without the policy expiring, so long as the cash value in their account is sufficient to cover the cost of the insurance. Also, in some cases, the amount of death beneﬁt can be adjusted to the individual’s needs or the policy can be used as a tax-free loan against the value of the policy.
While each of the above types of policies, can provide for a different aspect of your family’s ﬁnancial security, in divorce, the most important need for life insurance is to insure an ongoing obligation. In cases where your agreement calls for either spousal support, and/or child support, you will be responsible to pay that support on a weekly, bi-weekly, or monthly basis. While you are alive, there is no problem since you can make those payments. If you die prior to fulﬁlling your obligations, those payments will stop, leaving your family ﬁnancially vulnerable. Maintaining a life insurance policy, however, will insure that the ﬁnancial needs of your family will still be met.
Since funds are generally more limited upon divorce, a term life insurance policy may be the most cost effective way to insure an ongoing obligation. It can afford parents the most death beneﬁt they can afford, at a reasonable price. The earlier an individual purchases a policy, the less expensive it will be. Look to purchase a policy with a long enough term to cover your obligation. For parents with young children, generally a 20-year term will usually do the job. Hopefully, you can purchase a policy that if invested wisely, will be enough to cover not only the amount of your payments, but also leave enough to cover education costs, if necessary.
While it is helpful for both parents to leave a life insurance policy for their family, if only one policy is affordable, it makes more sense for the support payer to be insured. The obvious reason for this is that without the support payment, the family would lack the funds to support itself. Also, if the parent receiving the support dies prematurely, the children would come to reside with the support payer, and his/her support payment would be used directly to support the children. However, if ﬁnancial circumstances allow, a policy on the support receiver would help to defray the cost of child care, and future educational expenses if necessary.
While many people rely solely on the life insurance policies provided by their employers, it is a good idea to also have a privately owned life insurance as well, if possible. If you change employers, you will lose your life insurance policy, and perhaps your new employer will not have a plan available. Also, insurance premiums become more costly with each passing year. A term policy that’s cost was affordable at age 35, may be cost prohibitive at age 55. In addition, unexpected health issues may preclude you from being eligible for life insurance in the future.
While many divorcing spouses feel comfortable naming the other as the beneﬁciary under the policy, some spouses feel more comfortable naming a third party trustee. Either of these options are appropriate, but should you choose a third-party trustee, it is important that your agreement provide that said trustee must, without question, continue to pay the child’s support under the agreement, as well as provide the funds necessary for education purposes. This provision will greatly reduce the ﬁnancial stress and anxiety your family experiences.
If you choose to name a child as a beneﬁciary directly, you should be aware that the insurance company will be obligated to hold the funds until said child turns 18 years of age, at which time it will be paid out to the child. Because of this, the funds would not be available to the remaining parent to use for the purposes it was meant. In addition, most parents would agree, that most 18 year olds do not have the ﬁnancial experience to manage such a large amount of money. Therefore, this might not be the best decision.
As a mediator, whenever possible, I encourage the divorcing parties to provide life insurance for the duration of their obligation under the agreement. It is important to consider who should be insured, the cost of the policy, who pays the premiums for the policy, the amount of life insurance required, who will be named beneﬁciary or beneﬁciaries, and under what circumstances, if any, can the amount of life insurance be reduced. By careful consideration of these questions, and an exploration of the options available, you will most likely be able to provide for the ﬁnancial security of your family post-divorce, in a way that is comfortable to you.