By: Christine Cox-West, LUTCF
Last year I received a call from a client. He seemed upset and told me he and his wife were getting divorced. He asked me about changing the beneficiaries on his life insurance policy. My immediate response was, “before you do anything, discuss with your attorney first”. In the likely scenario that he was going to be required to have alimony and child support payments to his soon-to-be-ex, life insurance would be a key financial tool to ensure these payments would be made in the event of his untimely death.
The reason for life insurance is if a paying ex-spouse passes away, the payee would still need those payments to continue without substantial financial repercussions. Often when life insurance is required, the alimony paying spouse will purchase cheap term insurance with a term similar to the amount of years they are required to make payments. For example, if a spouse will need to make alimony payments for 18 years, they may purchase a 20-year term policy. If that individual has good cash flow, implementing a cash value life insurance policy instead of term may help them recoup those premium payments they were (probably begrudgingly) making. Here’s an example: Let’s assume John and Mary are going through a divorce. They are both 45 years old. Mary was a stay at home mom which gave John the flexibility to invest time and money into his business. When they divorce, Mary is awarded $10,000 per month of alimony for the next 20 years. Mary’s attorney explains that if John passes away one month into making his alimony payments, there’s almost $2,400,000 of alimony payments Mary won’t be receiving. Therefore, John must carry a life insurance policy for $2.4M. If John purchases a 20-year term policy for $2.4M he’ll end up spending nearly $84,000 over the next 20 years[1]. He’ll have nothing to show for it and his policy may lapse at that point. He spent this money and received no benefit for it. If John is earning significant income and has good cash flow, he can choose another option. If he instead chooses a “cash value” life insurance policy, he would spend around $940,000 in premiums over those twenty years. But based on current dividends of these kinds of policies, his cash value could be $1,203,000[2]. He’s “positive” $263,000 instead of down $84,000. That’s a $347,000 swing. At this point in time, he can decide what he wants to do. If he surrenders the policy he could take the cash. He would incur a tax on the $263,000 but, hey he’s still positive. The more likely scenario is that he chooses to keep the policy. He can choose to stop paying the premiums and redirect the annual dividends to pay the premiums. He can also use the policy to supplement his retirement income in a tax efficient manner by taking distributions from the $1.2M in cash value. There are additional benefits too. If John becomes disabled during those 20 years, the policy premiums could be waived. This means at age 65, the cash value will still be there. Cash value insurance can be used as a piece of a well-structured financial plan and can also accomplish long term care planning, estate planning for a future spouse or to leave a legacy for children. This solution isn’t for everyone but could work very well for some.
Regardless if cash value life insurance is appropriate based on
cash flow and net worth, life insurance plays an important role in protecting
alimony payments. Unfortunately, this year I received a call about that same
client I spoke of earlier. He passed away during his divorce. He was young and
he was a great father. At the end of the day, it didn’t matter what he would
have been asked to do in the divorce decree. He wanted his death benefit to go
to his ex to help take care of his children. Because he didn’t make a rash
decision last year by changing the beneficiaries, no one had to go to court to
fight for the death benefit. The mother of his children received the benefit
and the financial burden of his loss will be relieved. Whether cash value or
term, life insurance is critical to protect alimony payments.
[1] Based on a 2019 Illustration of Mass Mutual’s 20 Year Term Product of a 45 Year Old Male with a Select-Preferred Non-Tobacco Rating with Waiver of Premium.
[2] Based on a 2019 Illustration of Mass Mutual’s Legacy 100 Whole Life Product of a 45 Year Old Male with a Select-Preferred Non-Tobacco Rating with Waiver of Premium.
