Sharon Klein, a Family Wealth Strategist and Trusts & Estates Attorney, and Lee Rosenberg, a Family Lawyer, offer tips for leveraging life insurance in premarital planning and settlement agreements.
Dan: Sharon, what services do you offer and how do you work with family lawyers?
Sharon: Wilmington Trust offers the whole spectrum of wealth management services and in particular through the Matrimonial Advisory Solutions Group we offer a comprehensive suite of services to family lawyers like Lee who have clients who are maneuvering through divorce or are recently divorced. That could run from investing settlement proceeds, acting as a neutral independent trustee, reviewing business valuations, reviewing insurance, helping with family office services, helping with private banking, and more.
In particular, in the pre-divorce context, we have very sophisticated proprietary analytics that can run comprehensive financial projections that can take into account all assets, which might include private assets like a business that have very detailed cash flow projections, which could show the consequences of tax payments as well as the investment landscape. We could stress test a portfolio to see how it’s going to perform under different investment conditions. That information, that data that we produce is typically really helpful for a family lawyer to take to the negotiating table in order to best position their clients in the negotiation process. Then after divorce, we could use those same analytics to develop an investment strategy to invest a pool of assets that is designed to sustain a particular lifestyle, to give clients peace of mind as to their financial future.
Lee, where is the focus of your practice?
Lee: The simple answer is matrimonial and family law litigation, appellate work, trial work, negotiation and entering into marital settlement agreements, which would of course include prenuptial agreements, postnuptial agreements, separation agreements, cohabitation agreements, and anything in between.
What role does life insurance play in the context of divorce?
Lee: Well, primarily it’s designed to secure the financial obligations that are required to be maintained by the monied spouse for the benefit of the non-monied spouse. Usually we’re talking about the securing of spousal support, child support, and property distribution awards, but also sometimes we find it is additionally necessary when we’re dealing with certain types of retirement assets. You might have a situation where someone has been previously married and divorced and their pension or other retirement benefits that are a future benefit might not necessarily be available. You might have a surviving spouse annuity that is no longer available, a pre-retirement survivor annuity that might not be available, and so you need some other way of securing what is the remainder of the marital portion for the second marriage’s benefit. You need some methodology in order to make sure that if that spouse dies, that the surviving, non-monied spouse has some way to continue to effectuate that benefit as well.
Sharon, what are some of the pitfalls and mistakes that you’ve seen regarding insurance?
Sharon: Well, life insurance is a very peculiar type of asset. It’s not like an investment asset where you could call up your investment manager and see how your portfolio is doing. You can’t look at the insurance landscape and see how insurance is performing like you could open a newspaper and see how the markets are performing. Typically, you don’t hear anything from the insurance company unless it’s that letter that you get once or twice a year that says it’s time to pay your premium.
Life insurance is an asset that you really need to be proactive with. You need to have a periodic policy review to make sure that the policy is performing. That could pick up on a number of factors. The health of the insurance company, the interest rate assumptions, what were the interest rate assumptions at the time the policy projections were run, and has the interest rate environment changed? Does that negatively impact the projections that were made? If you have a life insurance policy that was issued before 2009, those policies were based on old mortality tables – and people are living longer nowadays. So it may be that you could secure a premium at a cheaper cost with the new mortality tables.
There are also so many other things. Has the health of the insured changed? Was there a health problem that he or she overcame that would reduce the premium payments? Or as Lee said, what was the original intent of the insurance? Was it to provide education for children who have now finished college? Those are the substantive points that you could pick up on a periodic policy review. Equally as important in my experience is to make sure that all the details are attended to, like the important detail of where are the premium notices being sent? Are the premium payments being sent to the correct address? Are the premiums actually being paid?
There’s one case that I think really highlights the risk of leaving those details unattended. It’s a case called the Orchin[CJ1] case. It comes out of DC, and in that case there was an insured who appointed his friend as a trustee. His friend paid the insurance premium for many, many years, and then his friend moved. Apparently, he didn’t communicate to the insurance company that he had moved, so the premium notices went to his old address until the policy eventually lapsed. This guy must have woken up in a cold sweat one morning, realizing that he hadn’t paid the premiums in a really long time. Do you know what jogged his memory that he hadn’t paid the premiums in a really long time? His friend died, and so the policy lapsed. His friend’s wife, the surviving spouse of the insured, sued the trustee for breach of fiduciary obligations for failing to maintain the policy. The issue was, did he take all necessary steps to notify the carrier that he had moved? There’s a lot of potential liability, and particularly in the matrimonial context, like Lee said, when you’re using insurance to secure an obligation, you have to make sure that the premiums are being paid. Because if someone dies and the obligation is unsatisfied and there’s no insurance to pay those obligations, it’s a big problem.
Lee: Sharon’s absolutely right. You’ve got a situation where that’s where the fashioning of these agreements is so important. Or if the matter is going to be tried, making sure that your court orders properly provide for the methodology where you make sure that the notices are going to the proper place, make sure that the premiums are getting paid, and make sure that the secured spouse has the ability to access the information.
Sometimes we have a situation where we want to make sure, for example, that there is an actual court order separate and apart sometimes from the judgment of divorce, which would actually be a life insurance order so that the insurance company itself and the successor life insurance companies have notice of where they’re supposed to be sending this information to. It’s also why sometimes we have a situation where we make sure that the secured spouse becomes the owner of the policy to provide for that information. Otherwise, you’re left in a situation where you could have an unsecured spouse, and then they have to go and chase the estate with the insurance company. Or if their spouse is not maintaining the premiums, then you’ve got post-divorce litigation for contempt and reinstitution of policies, and it becomes a giant post-divorce and sometimes post-death litigation.
Sharon: To your point, Lee, I think a good way to think of it is sort of insurance for the insurance.
When you have some sophistication as Lee does, and you put in these provisions that make sure that the policy is being paid and that the right people have access to the information to double-check that the premiums are being paid, it’s really insurance to make sure that the insurance doesn’t lapse. But I think you do need the sophistication to build in these provisions to be able to have the experience to know that there are cases, as Lee said when actions have to be maintained against an estate because a policy has lapsed. And there might not be enough money in the estate to cover the obligations, so it’s much better to be proactive and make sure that everybody is informed and that these kinds of obligations don’t lapse.
Sharon, are there any tax traps associated with owning life insurance?
Sharon: Yes, indeed there are, and I think one of the biggest tax traps is: how is the life insurance titled? Who owns the life insurance? I had a client come in and see me the other day. He had an obligation pursuant to a settlement agreement where he had to have a life insurance policy to secure his obligation to pay for the educational expenses of his children. He was divorced a long time ago, they were done with college, and so he didn’t need to maintain this policy anymore, but it was a valuable policy. It was going to pay out on his death, but he was the owner of the policy, and that meant that on his death, the life insurance proceeds would be includable in his estate, and we’ve top federal estate tax brackets at 40% and top state estate tax brackets at around 16%. That’s a lot of money that would be lost to taxes.
So, structuring the life insurance so that it’s owned by a trust or transferred to a trust, if that’s structured correctly, can make sure that the proceeds escape estate taxation and pass outside of the decedent’s estate. There have actually been cases when attorneys had been sued for malpractice because the life insurance hasn’t been titled properly and has been subject to estate taxes when it should have passed without estate taxes. It’s very important that when you do these policy reviews to make sure you know who owns the policy.
Can life insurance beneficiary designations be changed before a divorce is final?
Lee: Normally they shouldn’t be. In New York, like most states, the courts want to make sure that the status quo continues to be maintained and that nobody’s playing games with the beneficiary status of various things such as life insurance, medical insurance, beneficiaries of retirement benefits, and so on.
We have, at least in New York, automatic orders that go into effect, which essentially say, you cannot do this. Now, that does not mean that people can’t do it by agreement. It doesn’t mean that people can’t do it by making an application to the court for various reasons that might be legitimate, but by and large, the answer is no. You should not be making any kind of beneficiary changes. And it’s certainly incumbent upon the lawyer to advise their clients not to do that because they could ultimately be on the receiving end of an application for contempt and/or an application directing them to reinstate the policy. Now, reinstating a policy might not be as easy as it seems, because if they’re in a different age bracket than they were at the time that they took out the policy in the first place, whether they may have had interim health issues, whether or not there’s an issue of age, may be problematic for them. So, the answer is don’t do it unless you’ve got particular authorization by agreement or an actual court order permitting you to do that.
What if a spouse fails to remove an ex-spouse as a beneficiary of a life insurance policy before death?
Sharon: If people haven’t attended to their estate planning documents, including a life insurance beneficiary designation, in other words, somebody gets divorced and they don’t change the designation which remains in favor of an ex-spouse, what happens? Well in about half the states in the country, we have what’s called revocation on divorce statutes. That means if someone hasn’t revised their estate planning documents to reflect the fact that they’ve been divorced, on their death, these statutes can say that it’s as if the divorced spouse has predeceased the first to die, so they don’t inherit anything. The problem is only about half the states, as I mentioned, have these statutes, which means that the other half of the states do not. Even some of the states that have these statutes don’t extend to beneficiary designations on life insurance. Some of them only revoke beneficiary designations under wills and potentially trust agreements as well.
In my view, nobody should rely on state default law. State default law is there to fill in a presumed intent of what most people would have wanted had they focused on the issue. I think the best advice is to change those beneficiary designations as soon as you’re able to do so.
Lee: And just to add to that, this is another reason why it’s very important to have somebody like Sharon and also a matrimonial lawyer review these agreements as well as the underlying insurance documents to make sure you’re doing the right thing. Because again, as Sharon said, from state to state, it may very well differ. You could perhaps intend for a second spouse to get the benefit of the existing life insurance policy and not realize that you’ve already transferred the ability to do that away. You’ll end up leaving your current spouse with nothing, and the benefit will fall to an ex-spouse where there was intent to have that benefit fall to them. There are also federal statutes that are involved sometimes, or federal law that will actually go up to the United States Supreme court, or there’ll be a federal appellate decision. There are quite a few of them where you could have a situation where you’ve got federal preemption. For example, the person who’s maintaining the life insurance has to maintain it because they’re a federal government employee. There’s one case where there’s a statute in place which does not permit that spouse to do anything other than what their employment with the federal government tells them to do. Regardless of what the state court may say, the federal preemption supersedes what they might have otherwise intended to do.
Sharon: Let me just add onto that as well, because it’s not just the beneficiary designation that’s so important. You also have to look at the tax apportionment. Who is paying the taxes if life insurance is includable in the estate or passes to someone that generates an estate tax? Who is responsible for paying those taxes? There’s one case that came out of Georgia called the Smoot case[CJ2] , and it was exactly this fact pattern. There was a decedent who hadn’t changed the beneficiary designation on certain benefits that he had to reflect the fact that he was divorced from his spouse at the time of his death, and no revocation on divorce statutes came into play there. So, she actually ended up inheriting these benefits. But to add salt to the wound, it was found that the way the tax apportionment clause worked in the decedent’s will against the backdrop of Georgia law, his son of a prior marriage who was the remainder person of his estate was responsible for paying the taxes that were attributable to the benefits that his beloved stepmother received, so he lost the benefits and he paid the taxes. That is really a double whammy. So, you have to be mindful of the beneficiary designation and the tax apportionment issue as well.
Lee: There’s also a case in one of these states that had automatic revocation. In this particular case, the husband had changed the ownership of the policy to his ex-wife that superseded the revocation statute so that he had no control over what to do with that policy once he changed the ownership so that his surviving spouse, spouse number two in an intact marriage, tried to sue in order to get the benefit because of the revocation statute, but the court came in and said no. He lost the ability to make that revocation once he transferred the ownership.
So you have to be on top of it.
Lee: We all have to be on top of it.
What if the insurance is owned by a trust that names the ex-spouse as a beneficiary? Can the trust be changed to remove the ex-spouse?
Sharon: Well, that’s an interesting question and there certainly are techniques that can be considered. One technique is called decanting, whereby the trustee of one trust can pull the assets over into a new trust with different terms, and in that way, it may be possible to remove the beneficiary. Actually, there was a case in a similar context coming recently out of Connecticut, the Powell-Ferri case, where – not in the life insurance context, but it was a similar principle – the trustee of a trust was able to remove about a $100 million dollars worth of trust assets from a divorcing spouse by pouring those trust assets into a new trust with different terms that didn’t allow her to have a claim against the trust. In the life insurance context is actually a case coming out of New York called the Hoppenstein case [CJ3] where a trustee of a life insurance trust decanted the trust and poured the assets over into a new trust with different terms that excluded an estranged daughter of the insured and her issue. So that’s interesting. You have to be mindful always to observe fiduciary obligations and fulfill those fiduciary obligations.
But this is an area where matrimonial attorneys and trusts and estates attorneys can collaborate, and I get very excited about that collaboration. There definitely are techniques to explore. One of the things that people are doing now is drafting more flexibly so that you don’t name a particular beneficiary, and you leave it more flexible and open so that you don’t have a circumstance where you’ve named someone who you were happy to name, but times have changed, and you wish that person wasn’t there anymore.
Lee, have you had any cases where the spouse with the alimony or the child support obligation has died and the insurance kicked in? What happens if there is no insurance?
Lee: Well, certainly we’ve had that kind of situation and of course you have to go through the usual process of providing death certificates and making sure that the insurance company knows where the proceeds are supposed to go, but certainly we’ve had situations where they didn’t maintain the life insurance. Of course, that usually ends up in some form of litigation. Most of these agreements contain provisions in there that require the benefits and the obligations that are in the agreement to be binding upon once an heir’s successor is assigned. There’s usually also a provision in the agreement that provides for what happens in the event that they don’t maintain the life insurance. The obligation still continues as a result of that death. And as Sharon said, sometimes there are not sufficient assets in the estate – and that just becomes problematic. But you try and protect as best you can. You usually will maintain some kind of a provision in the agreement that talks about, making sure that the claim against the estate is going to be exclusive of any estate expenses where perhaps the existing administrator or executor of the estate is looking to pay expenses. And that’s coming off the top of whatever’s left. You want to make sure that the agreement provides that the whole amount that is required to be maintained is secured in its entirety without first devaluing the estate by its normal administrative expenses.
Sharon, do you have any final tips for somebody who’s acting as a trustee for a life insurance trust?
Sharon: Yes. Well, actually more broadly than that, if anyone is acting as the trustee of any trust. There are a lot of fiduciary responsibilities and obligations that need to be fulfilled, and oftentimes in the life insurance context or in the trust context, in general, people want to appoint friends or family members as trustees, and that’s a natural reaction. However, acting as a trustee is a very complicated job, and family members and friends rarely understand the full extent of the responsibility and potential liability that lies in wait. Oftentimes at Wilmington, we act as co-trustee with an individual because we bring our experience to the table about how to fulfill fiduciary obligations and document the fact that the trustees been doing so, and the family member brings knowledge of the family to the table. Oftentimes that’s a very important combination.
I will add that in the life insurance context, as we’ve been saying if there is a policy in a life insurance trust, those periodic policy reviews ensure that everything is performing and all the details are attended. Those are extremely important.
Anything else you want to add?
Lee: If I were to offer a tip, it would be: as a matrimonial attorney, when you’re dealing with an issue which is particularly nuanced, and which may very well be beyond your expertise, it is imperative to bring someone like Sharon in to do the analysis and make sure that you’re doing things the right way, that your language is correct, and to pick up on any particular nuances that you might not have foreseen so that you make sure that you’re doing the right thing by your clients.
I really appreciate both of your time today. I’m going home now to look at my insurance policy. I’m also a trustee of my friend’s estate. I’m going to get Sharon on the other side of that deal because I’m way out of my depth.
Sharon Klein is president of Family Wealth, Eastern U.S. Region for Wilmington Trust. She coordinates delivery of all wealth management services by teams of professionals and heads Wilmington’s National Matrimonial Advisory Solutions Practice. Beginning her career as a trust and estates attorney, Sharon has over 25 years of experience in the wealth advisory arena and is a nationally recognized speaker and author. She is a fellow of the American College of Trust and Estate Counsel and chair of the Domestic Relations Committee of Trusts and Estates Magazine where she’s on the Board. www.wilmingtontrust.com/divorce
Lee Rosenberg is a partner at Saltzman Chetkof & Rosenberg, LLP in New York. Lee serves on the American Academy of Matrimonial Lawyers, national executive committee, and on its New York chapter board of managers. He continues to be selected for inclusion in Best Lawyers in America. He is also a member of the New York State Bar Association Family Law Section executive committee, and is the editor in chief of their family law review publication. www.scrllp.com
[CJ1] Orchin v. Great-West Life & Annuity Insurance Company, 2015 WL 5726334, 133 F.Supp.3d 138 (2015)
[CJ2] Smoot v. Smoot, 2015 TNT 69-13, No. 2:13-cv00040 (U.S.D.C. S.D. Ga. March 31, 2015)
[CJ3] Davidovich v. Hoppenstein, 162 A.D.3d 512, 79 N.Y.S.3d 133 (2018)
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