Oftentimes, the purchase of life insurance is triggered by a life event; marriage, birth of a child, purchase of a home, job promotion, and sometimes by the death of a loved one. Divorce should be added to that list.
I remember one occasion many years ago when a spouse nixed the idea of additional insurance on her husband, because she had earmarked those dollars for the purchase of a new dining room set. You can imagine my surprise when, a couple of years later, she called to insist that he purchase additional life insurance, but this time it was because they were getting divorced.
Why would divorce trigger a need for additional life insurance? Because just as a surviving spouse wouldn’t have to worry about the mortgage payments if the deceased spouse had life insurance covering the mortgage, so a surviving spouse wouldn’t have to worry about the alimony or child support continuing if the deceased spouse have life insurance naming the survivor as the beneficiary.
Frequently, the terms of the life insurance are spelled out in the divorce decree. Unless the judge specifies otherwise, the terms are usually negotiated, as the receiving party will often seek an amount larger than the paying party is willing to fund. For example, if child support is set at $5,000/month for 10 years, the receiving party may ask that the funding party be insured for $600,000 ($5k x 120 months), while the funding party might seek to only insure the present value of that sum.
The amount the beneficiary is entitled to can and should be tied to the divorce decree. In the above example, if the payor died after five years, the beneficiary would only receive $300,000 (or the net present value thereof), with the balance going to either a different beneficiary or the deceased’s estate.
To prevent the possibility of the funding party letting the policy lapse, the receiving party should negotiate that the premium be included in the monthly amount to be received, be the owner and beneficiary of the policy and pay the premiums.
Life insurance in a divorce can be complex, involving both economic and tax issues. An advantage awaits the party who takes the time to learn about and prepare for such issues.