by Laurie Israel, Esq.
Divorce and Estate Planning
In many divorces, a spouse needs to provide child support payments for the living expenses and education of a child until the child’s “emancipation.” In Massachusetts, emancipation generally ends at college graduation or at age 23, whichever comes first. Child support helps divorcing couples achieve goals for the children in the manner they had envisioned when they were still married. Still, depending on the timing of the divorce, the period of time for payment of support can be long. Much can take place in the course of 10 or 15 or 20 years. What happens if the “payor” spouse dies prior to the time his/her support obligations have been completed?
Life Insurance as Aspect of Separation Agreement
Many couples choose to secure their support obligations through life insurance. Some already have life insurance. Others who are medically qualified may obtain new life insurance coverage or increased coverage at the time of the divorce. Providing life insurance policies to cover one’s support obligation is an excellent way to secure the costs of raising a child.
The topic of support obligations following the death of the payor spouse, with specific reference to life insurance, should be addressed in the Separation Agreement. What are the downsides to having the policy paid to the child? What are the downsides/advantages of having the surviving ex-spouse be the beneficiary of the policy? What are the benefits of having the life insurance policy proceeds paid into a trust? What happens if the payor spouse changes coverage while alive, or eliminates his/her coverage? What happens if the payor spouse changes the beneficiary designations? These and other issues can be addressed in a properly drafted life insurance provision of a Separation Agreement.
The Simple Approach’s Flaw
Some couples take what they think is the simple approach and have their insurance policies made payable directly to their child. This seems simple, but actually creates a difficult and expensive problem. In Massachusetts, a child is considered to have reached the age of majority at age 18. The policy proceeds will need to be paid to a court-appointed guardian (probably the surviving ex-spouse). The guardian has the legal obligation to administer the insurance funds on behalf of the child until age 18. At that time, whatever is left in the guardianship account must be given to the child outright. If you think back as how mature you were at age 18, you may want to reconsider naming the child as beneficiary of a life insurance policy.
The Custodian Approach
A somewhat better alternative is to leave the insurance proceeds to someone designated as “custodian” under the Uniform Transfers to Minors Act (UTMA) for the benefit of the child. You will need to check with your insurance company to make sure they understand the designation, and will acknowledge the custodian as the beneficiary of the policy. The designation must be to the custodian for the named child or children, and not be made to the child directly. In Massachusetts, the custodian can hold the property for the benefit of the child until age 21, at which time anything remaining in the account becomes the property of the child. The custodian may not use the funds for his/herself, but only for the child. The funds can be used for the child’s college education. For many couples, having the insurance funds be held in a UTMA account will be adequate to meet the support needs and not provide too much money outright to a child prior to their reaching age 21.
Making the Ex-Spouse as Beneficiary
Many couples, even if divorcing, wish to make their ex-spouses the beneficiaries of their support life insurance policy. If the designation is made with the intention of support of the children, the surviving ex-spouse is under a moral duty to use the funds as per the separation agreement, i.e., to replace the support the payor spouse would have provided. However, the proceeds are not immune from the ex-spouse’s creditors, can be affected by bankruptcy and may be subject to claims of his/her present spouse. Further, there is no guarantee that the surviving spouse will use the proceeds for the children. Even so, this is a solution that appeals to many people on the basis that they trust the ex-spouse to take care of the parties’ children in the event of the payor spouse’s death.
Elimination of Windfall
Another issue relevant to funding support obligations is that a windfall can exist if a large life insurance policy is paid out to secure a very small remaining amount of obligation. This can happen if the payor spouse dies a few years prior to the emancipation of the child. A way of eliminating this windfall is to have a decreasing schedule of required policy proceeds, depending on how old the child is. These can be figured out fairly easily by estimating the child support and educational cost contributions at various points. This permits the payor spouse flexibility in naming other beneficiaries as the children get close to emancipation.
Trusts, and the Necessity of Clarity
Some spouses choose to have the insurance paid to trust, in which a designated trustee (often a sibling of the payor spouse) receives the insurance proceeds and disburses the funds for the benefit of the child. Life insurance proceeds are part of the taxable estate of the payor spouse. However, if the insurance trust is irrevocable and meets other IRS requirements, the policy proceeds can be excluded from the payor spouse’s taxable estate.
The insurance provision in a Separation Agreement must be very clear that the funds expended would be equal to the support funds provided by the payor spouse had he/she being living. These would include child support and also payment of college educational expenses. The clearer the separation agreement is (as to what these expenses are), the more guidance the trustee will have in calculating what is required and avoiding conflict between the trustee and the surviving ex-spouse. The benefit of having a trust hold the policy proceeds is that it can also accept and administer additional funds of which the child is beneficiary — for instance, part or all of the payor spouse’s estate. The portion funded by the insurance as part of the Separation Agreement can be a separate share in a larger trust.
Three-Part Trust Disbursements
The trusts for the benefit of children that I generally draft have the trustee being able to support a child with income and principal at the trustee’s discretion (so that the child does not feel entitled to unearned funds at an early age). There is a three-part disbursement to the child, made at ages 28, 31 and 35. This permits the child to learn how to appropriately handle money gradually, starting at more mature ages than 18 or 21.
Life Insurance to Secure Alimony Payments
Life insurance can also be used to secure alimony payments in the event of the death of the payor spouse. Even though alimony per se will end at the death of the payor spouse, the payee spouse can receive a substitute for the alimony payments he/she would have received by means of the life insurance proceeds. This is often crucial support for the surviving ex-spouse. These policies can be paid to a trust (revocable or irrevocable) as with the trusts for the benefit of children.
Vital Provisions for Separation Agreements
The insurance provision of a Separation Agreement should specifically provide for a number of things. The Agreement should state that if the payor spouse does not leave the insurance policy proceeds required, whatever is missing will be a claim against the payor spouse’s estate (as well as any other remedy provided at law, such as equitable claims and trustee actions) and that the estate must pay any attorney’s costs incurred in enforcing this provision. A claim for missing proceeds of an insurance policy can be made against the estate, or as an equitable claim against the party (often a new spouse) named as beneficiary of the life insurance proceeds, in contravention of the separation agreement. See Foster v. Hurley, 444 Mass. 157 (2005). The Separation Agreement should specify that if subsequent life insurance policies are purchased, they shall be deemed to be intended for the benefit of the payees under the current Separation Agreement to the extent of the support amounts or policy face amounts required under the agreement. This means that the prior obligation cannot be circumvented by buying new policies and canceling the old one. In order to prevent changes in beneficiary designations and insurance policy amounts, the payor spouse should be required under the agreement to give the other party yearly proof of insurance coverage.
Should the Recipient Ex-Spouse or Trust Own the Policy?
One way to eliminate the problem of a payor spouse changing the beneficiary designation of a life insurance policy is to have the recipient (the ex-spouse, or trust for the benefit of children) own the policy. The payor spouse would be the “insured”, but the owner of the policy would have the right to change (or not change) beneficiaries. The question of who pays for the policy premiums could be an issue addressed in the Separation Agreement. The downside of having the payee own the policy, is that it does not necessarily address the issue of scaling down the amount to be paid for support as the child approaches emancipation. The scale-down of proceeds could still apply in the hands of the owner, with the excess required to be paid to the payor spouse’s estate. The Separation Agreement could require the policy to be transferred back to the ownership of the payor spouse if he or she lives after his/her obligation to support terminates.
Providing for support obligations through life insurance is an excellent way of securing the obligations of a payor spouse in a divorce, and great care should be giving the life insurance provision in a Separation Agreement.
Copyright ©2007 Laurie Israel.