Most people know very little about the intricacies of life insurance. Here are the top 10 life insurance issues in divorce for you to consider.
Noah Rosenfarb
MML Investors Services — New York
Life insurance is a commonly used product, but most people know very little about its intricacies. Here are 10 things you should consider when dealing with life insurance in a divorce proceeding.
If either party owns life insurance prior to the filing of a Complaint about Divorce, here are four things to consider (4 out of 10):
1. Permanent insurance may have value beyond the cash surrender value listed on the statement
Anyone with terminal health issues and/or anyone over 70 has a reasonable chance of receiving more than their cash surrender value for their policy. Recently, Cantor Fitzgerald launched “LexNet” — an online marketplace dedicated to the trading of life insurance policies — which has made the sale of policies more efficient and cost-effective.
2. Term insurance, despite having no cash value, may also have value
If the insured’s life expectancy predates the expiration of the policy, there may be someone willing to buy the policy. For example, a client had 4 years remaining on his $5,000,000 term policy when he was diagnosed with terminal cancer. The policy was quickly sold for $3,500,000 (to a hedge fund).
3. Whole life insurance is a desirable asset
Whole life policies pay dividends, and cash values accumulate tax-deferred. The dividend rate on “paid up” policies generally exceeds bonds rates. So, if a policy is 10 years old or older, it is an attractive alternative to a typical bond portfolio.
In most cases, the insured keeps the life insurance policy and pays half the cash value to their spouse. However, since this asset has many desirable features, consider arguing to retain the policy whether or not your client is the insured.
4. Before liquidating a policy to satisfy equitable distribution, consider a 1035 exchange
A 1035 exchange allows an insured to “roll” the cash value of a life insurance policy into an annuity without any immediate tax consequence. This may be an attractive alternative to paying tax on the liquidation of a policy.
If a Matrimonial Settlement Agreement requires a party to maintain life insurance, here are six things to consider (6 out of 10):
5. The insured should go through the underwriting process prior to signing the settlement agreement
If coverage will not be available due to health issues, or if the premiums are prohibitively expensive, other provisions should be included in the settlement to protect against pre-mature death, such as the creation of trusts or other estate planning tools.
6. Minor children, either individually or via a Custodian, should not be named as beneficiaries
This error is far too common, as the consequences are either unknown or not contemplated. Any payments with this designation will be placed into an UGMA account if the child has not reached the age of majority. If the Custodian is not listed on the beneficiary form, one will be appointed – and it may not necessarily be the surviving parent – a problem in and of itself. More troublesome, is that the child will receive unrestricted access to 100% of the account upon reaching the age of majority – their 18th birthday in most states.
7. If a “Trust” or “Trustee” is listed as a beneficiary and no trust exists, the death benefit will be paid to the owner of the policy
If the owner was the insured, it will be paid to their estate. Again, this designation has no relevance unless a trust is created prior to the death of the insured.
8. The reference to an “Adult Payee” does not create a fiduciary obligation
A mother named as “Adult Payee” for her children’s entitlement from their father’s life insurance proceeds imposes no legal obligation on the mother to utilize those proceeds for the benefit of her children. Do not create the false impression that it does, or you may expose yourself to potential malpractice claims.
9. There may be tax advantages to having the non-titled spouse (beneficiary) own the policy
Most Agreements instruct the titled spouse to obtain, own and pay for the policy. Upon their death, the non-titled spouse would receive the appropriate amount of the insurance death benefit. This could create unwanted estate tax issues for the insured.
Instead, consider structuring the agreement so the non-titled spouse obtains, owns and pays for the policy, with themselves as the beneficiary. This excludes the life insurance proceeds from the estate of the titled spouse.
This could also be accomplished through the use of an Irrevocable Life Insurance Trust (ILIT) to own the policy, but the costs to establish and maintain the trust must be considered.
10. The beneficiary should receive premium notices
Irrespective of ownership and/or payment terms, the beneficiary must be notified by the insurance company of the status of the policy. “Proof of insurance” – often required to be provided by the insured annually – fails to provide the beneficiary with proper notice to keep an insurance policy from lapsing. If the insured stops making payments, the beneficiary should be notified so they can take appropriate action.
(Reprint with permission)
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Noah B. Rosenfarb, CPA is Managing Director at Freedom Divorce Advisors where he provides sophisticated tax and financial advice to affluent divorced women. Mr. Rosenfarb integrates life planning with financial planning to ensure clients experience the maximum benefits of affluence post-divorce. His holistic approach increases the probability of leading a life that is filled with prosperity – the kind that is measured more by personal happiness than merely by currency.
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