When dealing with the financial ramifications of divorce, life insurance is easy to overlook. After all, assuming both parties are still alive, life insurance has only been an expense so far, and any financial payout is far in the future. However, life insurance is an important asset and needs to be handled with care during and after a divorce. Life insurance in a divorce can be best managed when answering the details below.
Divorce and Life Insurance Types: Term Life vs. Whole Life
If you are in the midst of a divorce, it is important to understand the difference between the two most common types of life insurance: term life and whole life.
Term life insurance is insurance that is valid for a specific period of time. 10 year, 20 year, and 30 year terms are very common, though the term could be any period agreed on with an insurance company.
With this type of insurance, payments are made each month until the end of the term, at which point the policy ends. There is generally no large value in a term life insurance policy unless the insured passes away.
Whole life insurance is marketed as an investment product. The insured makes payments similar to term life, but at the end of the policy there is a cash value that can be withdrawn. Whole life policies can typically be closed at any time, at which point the current value is cashed out.
One of the biggest divorce life insurance issues is understanding the value of a policy. Term life does not generally carry a significant cash value, while whole life does.
Determine Life Insurance Policy Ownership Before Getting Divorced
Most policies are owned by the insured individual. While the policy may be considered a shared asset by the divorce court, that is not always the case, particularly for term life insurance where there is no major asset value.
If the policy is owned by the insured individual, that owner has the right and ability to change the beneficiary of the policy at any time. The only exception is in the event of a divorce decree that orders the owner to set a specific beneficiary.
If life insurance was not specifically discussed in a divorce decree, you can do whatever you want with your life insurance policy after divorce.
Should You Keep or Cash Out Your Life Insurance Before Getting Divorced?
If you have a whole life policy and the ex wants to include that policy in the divorce settlement, you may be best off cashing out and getting a new life insurance policy. Remember that rates are based on age and health, so the cost of a comparable policy may be higher today than when you signed up.
If you decide to cash out, both parties typically each get half of the policy value. If you keep the policy, you can change the beneficiary per the divorce decree, or if it was left out of the settlement you can make the beneficiary anyone you choose.
Who Should Pay?
If you decide to keep your existing life insurance, you have a new set of questions. One of the most important is who should be making the monthly payments going forward.
In some cases, a parent with childcare responsibilities chooses to pay for life insurance on the ex spouse who is paying child support and alimony to insure against losing that income. In other cases, the court orders the higher income earner to keep a life insurance policy with the ex or children as a beneficiary.
Who Should Be the Life Insurance Beneficiary?
After separating, the first reaction is to remove your ex as a beneficiary. This is often the right move, but think twice before doing so. If your ex is taking care of your children, you may still want them to receive a payout in the event of your death.
In other cases, you may want to make the beneficiary a sibling, parent, or adult child. Remember that a policy can have multiple beneficiaries who share in the payout, so you do not have to make an all-or-nothing decision.
Can a Minor Be a Beneficiary?
Life insurance companies will not pay proceeds from a life insurance policy to a minor. However, there are several options that can allow you to make a payout for the benefit of children regardless of age.
One option is to designate a trust for the benefit of the minor, in which case the funds will be saved until the child turns 18 or 21, depending on how the trust is setup.
You can also name an adult custodian under the Uniform Transfers to Minors Act or choose an adult beneficiary who will be responsible for the child’s care taking.
If I Update My Will, Is My Life Insurance Updated?
Divorcees make a common mistake where they update their will but not their life insurance. If you update your will to designate your child or anyone else as a beneficiary, that does not change your life insurance.
Your life insurance beneficiary is set with the insurance company, and your will has no impact on who the insurance company pays. They are completely separate.
If your old life insurance becomes part of your divorce, you may want to get a new policy as quickly as possible. Because the cost goes up with age, you will never get as good of a deal on life insurance as you can right now. If you want to protect your children, other family members, or future spouse in the event of a worst case scenario.