How Life Insurance Works in a Divorce

Among the messy tasks that come with a divorce, sorting out life insurance is often overlooked. In the midst of divvying up assets and, if you are a parent, ensuring your children adjust as smoothly as possible, figuring out what to do with life insurance sometimes falls by the wayside. Don't let it.

Dealing with life insurance is an important part of the divorce process. This is especially true for divorcing couples who have children. Keeping life insurance in order protects the financial interests of both parties and their dependent children. This process involves making necessary beneficiary changes, accounting for the cash value in whole or universal life policies, protecting alimony and child support income, and most importantly, ensuring that any children involved are financially protected, no matter what.

Update Beneficiaries

The purpose of life insurance is to protect those closest to you from financial devastation if you die and your income is lost. Most married people with life insurance list their spouse as the primary beneficiary. Having your spouse as your beneficiary ensures that they can keep paying the mortgage or rent, put food on the table, and—if applicable—raise the children without your income. Having life insurance is especially important if you provided the majority of the income.

In the case of a divorce, particularly an acrimonious one, there is a good chance you will no longer want your ex-spouse profiting from your death. If no children are involved, few good reasons exist to continue having an ex-spouse as your life insurance beneficiary.

Most life insurance policies are revocable, meaning the policy owner may change the beneficiary at any time. Some appoint irrevocable beneficiaries, in which case the beneficiary, once designated, cannot be changed. The easiest way to change your beneficiary after the divorce is to contact your life insurance agent so that they can verify if the policy is revocable and redesignate your beneficiary.

Account for Cash Value

Some life insurance policies, particularly whole life and universal life policies, accumulate cash value over time. Each month when you make your premium payment, a portion of that money enters a fund that grows with interest. The balance of this fund is the policy's cash value. This is your money. At any point, while the policy is active, you may elect to forgo the death benefit and instead take the cash value. This process is known as cashing out your life insurance policy.

The cash value from a life insurance policy represents part of your net worth as a couple. The most equitable thing to do is to list the life insurance policy, including its cash value, among the marital assets to be divided. In a divorce in which assets are divided evenly, this means each spouse leaves the marriage with half the cash value from the policy.

Protect Alimony and Child Support

Protecting alimony or child support is especially important for the spouse who takes primary custody of the children after the divorce. Child support from the noncustodial parent is supposed to go toward feeding and clothing the children, among other expenses. If the worst happens and the noncustodial parent isn't around anymore, this income is lost and potentially leaves the custodial parent in a dire situation.

If you have custody of your children, the most prudent way to protect yourself from this scenario is to maintain a life insurance policy on your ex-spouse with a benefit amount high enough to replace your child support or alimony income at least until the last child is grown.

Single Parents

One of the biggest challenges of divorce is that it frequently turns people into single parents. Sadly, many parents find they can't rely on their ex-spouses, financially or otherwise. Divorced people in these situations become their children's sole caretakers. Should this happen, have a plan in place.

With your ex-spouse no longer in the picture and your children relying solely on you for financial support, if you die, they have nothing. Without your income, your children have no way to feed or clothe themselves, much less provide anything beyond the basics. A guardian—either a relative or someone appointed by the state—will assume the care of your children (you should update your will to establish a guardian). Even if you've made plans, there are still many unknown factors in this situation.

If divorce makes you a single parent, you need to take out adequate life insurance on yourself to protect your children or other dependents. To determine the minimum benefit amount, calculate how many years you have until your youngest child turns 18 (or, to be extra safe, 21) and multiply this number by your annual income.

For example, if you make $50,000 per year and your youngest child is 6, a death benefit of $600,000 will replace your income until that child is 18. A $750,000 benefit would see the child through until the age of 21. Choosing the larger benefit amount can be prudent as long as the premiums are not too oppressive. If you want to be even more conservative, it may make sense to purchase a policy with an inflation rider to take rising prices into consideration.