Contributed by: Jacki Roessler, CDFATM
Years ago, I got a call from Lindsay, a divorced client that still sends shivers down my spine. Her divorce had been final for two years when her ex, Justin unexpectedly died from a heart attack. In order to maintain her living expenses, Lindsay had been dependent on Justin’s monthly child support payments for their two young children. Once the initial trauma subsided, Lindsay pulled out her divorce decree and breathed a sigh of relief; Justin had agreed to maintain a $250,00 life insurance policy to secure his child support payments.
So; why the phone call?
Justin missed a premium payment and the policy lapsed. Lindsay’s child support income was gone and despite their divorce agreement, there wasn’t anything to replace it.
The worst part of this situation was how easily it could have been prevented.
Taking a step back, there are four parties to every life insurance contract; the insurance carrier, the policy owner, the insured (the measuring life) and the beneficiary.
Life insurance is a legally binding agreement that the carrier will make a lump sum payment to a designated beneficiary upon the death of the insured-in exchange for annual premium payments.
The simplest and easiest solution was to require Justin to transfer ownership of the policy to Lindsay at the time of the divorce. He would have remained the insured and the person responsible for premium payments. However, when payments are missed, it’s the owner who’s notified, not the beneficiary. Once a policy lapses, it’s too late to reinstate it. A new policy can be obtained, but only if the insured is still in good health and is willing to cooperate with the application process! Lindsay could have made the delinquent payment herself and then attempted to enforce the divorce agreement directly with Justin or through the court system. Either way, the policy would have stayed in force.
In my experience, attorneys can be very uncomfortable insisting on policy ownership transfers.
By the time agreement’s reached on the parenting schedule, alimony and who gets to the keep the house, no one wants to see the case fall apart over who owns the life insurance policy. As it was in Lindsay’s case, this was a disastrous mistake on her attorney’s part.
As an additional reason to change ownership on the policy, keep in mind that only the owner can change the life insurance beneficiary. Suppose Justin had remarried and decided to switch the beneficiary to his new wife. Sure, he would have been in default of the divorce decree, but there wouldn’t be any consequences to that once he’s dead.
Another unexplored option in this case was to request that the insurance carrier send duplicate statements to Lindsay, the beneficiary. Since the divorce decree itself isn’t legally binding on third parties (like the insurance carrier), there isn’t any real way to force this on the carrier, but some will comply.
A last option would have been a requirement that Justin pay annual premium payments instead of monthly. Although most people prefer to make monthly or quarterly payments on insurance contracts, this would have provided Lindsay with less to follow up on. Rather than being forced to confirm monthly payments, she’d only have to confirm once per year.
Luckily, Lindsay’s kids were eligible to receive Social Security survivor benefits, which helped replace some of the child support income and she was eligible for widows’ benefits while their children remained minors. Despite that, she was still forced to sell her house.
The moral to this tale? Sometimes the issue that seems nit-picky or trivial is the one that can unravel someone’s finances after a divorce. If you’re dependent on an income stream to pay your bills, make sure you understand how it can be protected and then insist on it before you sign your judgment of divorce.
Are there any other tax issues or potential financial pitfalls related to life insurance and divorce? Glad you asked and yes, there are! Stay tuned for my next blog!
Jacki Roessler, CDFATM is a Divorce Financial Planner at Center for Financial Planning, Inc.®