December 1, 2012
Alimony, or maintenance, is often awarded in a divorce. In order to have alimony be tax-deductible to the payer, the payments must stop upon the payer’s death. Were the payer to die however, the recipient would lose an expected stream of income. A simple way to cover those lost payments is to have the divorce decree stipulate that life insurance will be carried on the life of the payer in an amount that will replace the alimony in the event of the payer's death.
Always recommend that the recipient own the life insurance policy and make the premium payments. This prevents any changes in the policy without her knowledge. (We will assume in this report that the wife is the beneficiary.)
Another option is to have the wife be an irrevocable beneficiary. This prevents any changes in the policy without her knowledge. Consider what happened to Joan. She was receiving $400 per month in alimony from her ex-husband Jerry. The court had ordered Jerry to carry life insurance on his life, payable to Joan as long as alimony was being paid. After three years, Jerry was tired of making the insurance payments so he stopped and the insurance was canceled. Nobody knew about it until one year later. Jerry was in a car accident and died two weeks later of complications from his injuries. There was no life insurance. Yes, Jerry was in contempt of court, but it didn’t make any difference.
If a new policy is to be purchased, it should be done before the divorce is final. In one case, Bob agreed to buy a life insurance policy to insure his maintenance payments to Nancy. After the divorce was final, he applied for the insurance and took his health exam. He was found to be un-insurable. If Nancy had known this before the divorce, her lawyer would have asked for a different settlement. It was now too late.
Also recommend that, if the wife can afford it, the life insurance build cash value. Then, the cash account within the policy is hers to do with whatever she wishes. She may even use it for retirement. She can borrow from it at any time, or cancel the policy and use the cash.
Another option would be to purchase level term insurance for the life of maintenance if the wife can’t afford the premium payments for the cash value policy. She could “buy term and invest the difference” in a mutual fund that she can watch and manage.
If the court orders the husband to purchase insurance to cover maintenance and/or child support and the wife owns the policy (while he makes the premium payments), those premium payments are treated as maintenance for tax purposes and he can deduct them from his taxable income. Likewise, the wife will need to declare them as taxable income, unless the parties agree in their separation agreement to exempt the payment from the alimony tax treatment.
Is term insurance ever a marital asset? Yes, in some states if the insured has since become uninsurable, it could be considered an asset.
Insurance is a good way to protect alimony and child support payments that the receiving party is dependent on. A Certified Financial Divorce Analyst can determine the right amount to buy, and the appropriate type of policy to put in place.
