February 1, 2016
When alimony and child support are awarded in a divorce, it is strongly recommended that these payments be secured. If the payor becomes disabled or dies, the ability to continue payments could be in jeopardy. The need for payments would not go away but the ability to pay would – a situation you don’t want your client to experience.
Typically, life insurance is used to secure support payments. The structure of the insurance policy depends on the details of the payments. If the payments are for a limited amount of time, most likely a term insurance policy will fit the need and be the least expensive solution. For lifetime or very long-term support a whole life policy may be a better alternative.
Some payors will object to holding a life insurance policy. Often this is because the payor feels the payee might benefit unjustly as the policy could provide more benefits than required. As an example; John is required to pay $500 per month in child support for 10 years. He takes out a $60,000 life insurance policy to cover his obligation and makes Julia, his ex-wife, the beneficiary. Four years later John dies and Julia receives the insurance proceeds. By this time John’s obligation had been reduced to $36,000 but Julia receives all of the life insurance proceeds of $60,000, thereby getting a bonus of $24,000. There are several ways to avoid this situation.
John might be able, from time to time, to reduce the death benefit of his policy (if his carrier allows.) Another possibility is to set up an insurance trust, called an Irrevocable Life Insurance Trust (ILIT), to own the policy as well as be the beneficiary of the proceeds. The trust document would allocate the life insurance to the ex-wife according to any remaining obligation and other beneficiaries could be named to receive the rest of the proceeds. A third possibility is for John to take out several policies; two policies for $30,000 each or 3 policies for $20,000 each, and drop a policy as time goes on.
Some payors object to taking out life insurance because of the cost. Policies can be expensive if the payor is in poor health or exhibits undesirable habits such as smoking, obesity or even a poor driving record. Some individuals might even be uninsurable due to their medical history. In this case a property settlement could be used, equal to the present value of the support payments. This is a good substitution as long as the property given is liquid and doesn’t come with any tax implications.
Life insurance doesn’t cover the payments if the payor becomes disabled – a more likely situation than an untimely death. Therefor a disability policy should be in place. Many employers offer long-term disability plans that are cost-effective. However the benefit payment may be limited as well as the length of time payments are made. Most importantly the definition of disability can be restrictive, making it hard for the employee to qualify for benefits. Securing a disability policy outside the workplace is the preferred solution.
Although the need to secure support payments is universal, every client’s situation is different. Both parties will want to take steps to insure the payments for the right amount and length of time.