Under normal circumstances, people take out life insurance for different reasons, eg, income replacement, providing finances for their loved ones, loan collateral, paying off a mortgage, and so on. And while taking out a life insurance policy is voluntary, sometimes the court may order you to get a new one or maintain an already-existing one. During a divorce settlement, one of the spouses may be ordered by the court to get an insurance policy to meet the requirements of the settlement, and this is referred to as court-ordered life insurance.
When You’ll Need It
For anyone undergoing a bitter divorce, it would be understandable if they didn’t want to carry a life insurance policy which their ex-spouse is benefitting from. But even when the divorce is a bitter one, you need to reflect when a life insurance policy would be necessary. That said, below are instances where you will need court-ordered life insurance.
To Secure Child Support
When a court issues child support payments to be made, this is to ensure that the minor involved during a divorce receive support similar to that they would have received before the divorce. It is normal for the custodial parent to be concerned about how they will support their children post-divorce if the insured ex-spouse dies before all the child support payments are made. To ensure that your child continues to receive financial support even after the paying parent dies, you can take out a life insurance policy.
This also applies to the other ex-spouse, should the primary custodian die, they are left with not only the custodial responsibility but also the financial responsibility of the children. So the life insurance policy is a way of protecting the future of the children with either of the parents absent.
How the Amount is Calculated
When the court orders you to take out life insurance, the amount of the policy usually aligns with the child support obligations. In most cases, child support payments are made until the children reach 18 years, and in a few cases beyond that age. Here is a simple example to give you a hint of how the court might come up with the policy amount.
Say you have three children aged 10, 12, and 15, then you have 8 years of child support left for the youngest kid, 6 for the middle child, and 3 for the eldest, making the total number of years 17. If you are required to pay $2,600 every year for each kid, or $7800 yearly for all three, then the policy amount will be worked out down to the month. In this case, you will have 17 years x $2600, which is $44,200. So, you might be ordered to take out a life insurance policy of $45,000.
Should You Name the Ex-spouse as the Beneficiary?
In many situations, the insured spouse names their ex-spouse as the beneficiary of the policy. Since they are the primary custodians of the children, they are morally bound to use the policy payments for its intended use, which is supporting the child. But, naming the ex-spouse as the beneficiary could have its downsides.
For instance, they are not legally required to use the payments for child support, hence they might end up using it for their own gain other than that of the child. Also, a current partner might claim the proceeds of the deceased which leaves the custodial parent named as the beneficiary without enough financial support for the children. Also, if the paying ex-spouse files for bankruptcy, then this would automatically affect the life insurance policy.
Naming the Child as the Beneficiary
Some people opt to name their child as the primary beneficiary of the policy. But this might not be the best option, especially if an untimely death of the paying parent occurs leaving a minor behind. This leaves the court the power to appoint a guardian for the child who receives the policy benefits. This is usually the surviving parent.
And if the child turns 18 years and receives the benefit, how certain are that they will use the funds responsibly? These are some of the things you should consider before naming the child as the policy beneficiary.
Naming a Custodian as the Beneficiary
Since you are divorcing, the best party to name as the beneficiary of your policy is a “custodian”. So, instead of naming your ex-spouse as the beneficiary having a custodian as the beneficiary ensures that the child receives the funds when you want them to. The age of majority in most states is usually 18 years, but trust termination is often done at the age of 21.
Also, when you name a custodian as the beneficiary, discuss with your insurer to ensure that they know your designation and recognize the custodian as the beneficiary.
Which is the Best?
In any of the situations, any concerned paying parent only hopes that the policy benefits are used to support their kid. Violating the court order to take out the insurance policy is not an option, so the best way to ensure that your children receive the funds when they become of age is through a trust.
The designated trustee will be in control of the policy benefits once they are paid out after your demise. This means that the trustee is responsible for using the funds to pay for the child’s needs eg college fees until they turn 18 or 21 and are able to manage benefits on their own. By naming a trust as the beneficiary steers you clear from probate, meaning that the funds will be available to the child immediately without expense.
The Windfall Challenge
A windfall occurs when the insurance company pays out a very large benefit amount for a very small support obligation. This often happens when the paying parent dies a few years before the support obligations are fully met, leaving the child with a financial gain large than what is actually needed.
To counter this future possible problem, a reducing schedule arrangement is made with the insurer hence, the costs of every child are calculated at every stage to ensure they are covered adequately. This kind of arrangement has the advantage of flexibility because if the paying parent has other children with a current spouse, the remaining amount can be used to sufficiently cover for their needs as well.
To Protect Alimony
When a supporting ex-spouse dies, the alimony dies with them, leaving the surviving ex-spouse with a financial burden. During the divorce settlement, the court orders the paying spouse to take out a life insurance policy in order to secure the alimony payments in the case of their untimely death.
A good attorney can make an estimation of the amount to be paid as alimony under different grounds, ie, the expected life expectancy of the ex-spouses, the terms of the settlement agreement, expectations of the retirement period, etc. Some of these factors, however, only apply in the case of open duration alimony.
These terms can also be affected by life changes such as loss of employment or remarriage, but how much life insurance needed is usually determined by using the current value to estimate an adequate amount to sustain the receiving ex-spouse in the future. Also, the alimony commitment might be lower later, with the leftover term less as well. When setting up an agreement, the settlement should have a stipulation that caters for the reduction of the policy obligation.
There are a few instances a situation may be deemed special, affecting the court’s order of the life insurance requirement. They include;
- Previous history of the failure to pay alimony
- The age of the parties, ie if they are too old
- Illness of the paying spouse
- If the paying spouse is involved is a dangerous occupation
- Presence of other wealth owned by the receiving spouse
- If the recipient is a custodian of minor children
- Violation of previous agreements requiring the maintenance of life insurance by the paying party
- Disability or illness of the spouse receiving alimony
- Lack of the capacity of the receiving spouse to sustain their lifestyle should the alimony payments stop
For the court order on the paying spouse to maintain insurance to be upheld, these instances should be presented prior to the final judgment. This should also be backed by evidence to help determine the amount of the policy, the ability of the paying spouse to afford premiums, and if they are insurable.
The receiving spouse may be named by the court as the owner of the policy. This means that they receive notices and other communication from the insurance company. Such a change would be necessary if the paying spouse has, in the past, disobeyed their court-ordered obligations. Also, if the paying spouse violates the court order to maintain a life insurance policy but later complies before compliance enforcement is filed, this does not fully rid the violation.
Life insurance is a continuous commitment hence during a divorce settlement, the provision is subject to post-judgment modification if evidence of significant life changes is presented.
Protection of Mortgage
While this is not common, court-ordered life insurance can be used for protecting mortgage. With most divorce settlements, the spouses usually choose to sell off all the property and split the earnings. In some instances, the ex-spouses might mutually decide to keep their previous house for the sake of the children. If this property was still under mortgage, life insurance can be used to ensure that the mortgage payments are made to the end.
How to Get It
Now that the court has issued an order for you to get a life insurance policy, you should apply for it as soon as possible. Your application will take about a month or so to get approved, but it might take longer where more information is required. The best time to start shopping and applying for an insurance policy is a few months prior to the court’s deadline as it helps avoid last-minute rush and frustrations.
Depending on underlying factors, the policy might need to be set up with the supported spouse as both the owner and beneficiary of the policy or with the paying spouse as the owner and the supported spouse as the irrevocable beneficiary.
The best way to get life insurance is to find an experienced agent who will help you select the best policy depending on the requirements of the court. If you discuss your needs with him/her, they will be able to help you select the best insurers with good deals.
It is necessary to get proof from your insurer for the court after you take out the policy.
Divorce proceedings vary depending on the circumstances, so it is important to have an attorney every step of the way. How you handle existing or new life insurance with your ex-spouse will be determined by circumstances on both ends. Don’t make any decisions without informing them as any action might lengthen the proceedings or make them complicated than they are. The last thing you want is to violate the court’s guidelines, even if done unintentionally, it might have harsh consequences.