Life insurance and divorce settlements

by Shannon Burke
11 min read

KEY TAKEAWAYS

  • Most married couples name each other as the beneficiary on their life insurance policy, which may need changing if you separate or divorce
  • To change your beneficiary after separation, you have to go through your insurance company or speak with your advisor of record. If the policy is irrevocable, you will also need agreement from the existing beneficiary
  • Some post-separation agreements stipulate that divorced couples are required to hold insurance policies to cover any shared expenses like child care
  • If you change the beneficiary of your life insurance policy to your child(ren), make sure to appoint a trustee or establish a trust as they may be too young to receive the funds legally

Sometimes “happily ever after” doesn’t work out. Although there’s a tremendous emotional toll, divorce also comes with financial consequences, such as spousal and child support payments, equalization (dividing up you and your former spouse’s properties), and legal fees. Your evolving personal and financial circumstances may lead to changes in your life insurance needs. Additionally, you and your ex may also be required to purchase new life insurance policies as you proceed through your divorce settlement. 

This article provides some insights on why you may want to review your existing life insurance policy through a separation and how purchasing new life insurance may transpire post-divorce. Lastly, the article touches on the pros and cons of designating your children as your life insurance beneficiary instead of your ex-spouse.

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What happens to your life insurance policy after a separation?

Married couples will often purchase life insurance together as they embark on their new lives, buy a house together, raise a family, and meet other financial and lifestyle responsibilities. Most will appoint their spouse as the primary beneficiary on their life insurance policies. As you untangle your financial lives, there is no automatic change to your life insurance coverages or beneficiary designations.

How is an insurance policy equalized between spouses?

Another critical consideration in a divorce is how to divide financial assets between you and your partner. Assets such as your home, joint savings accounts and emergency funds, and investments may be split evenly between each person unless a marital or divorce agreement begs to differ.

A term life insurance policy won’t be part of these financial assets considered for equalization, but the cash value of a permanent or whole life policy will commonly be. 

The process to follow to separate your life insurance coverage will depend on the type of life insurance policies you hold. Separating your life insurance coverage is easiest if you both hold individual term life insurance policies, where each spouse is the individual owner of their respective coverage. In such a case, the individual spouses can continue with their coverage independently post-separation. 

If you hold a joint first to die life insurance coverage, you may choose to assign the coverage to one of the partners or work with your insurance advisor to split the coverage into two separate policies. Most companies allow coverage to be split in the event of a marriage or common-law relationship separation. There are usually additional requirements – such as minimum coverage amounts of the new policies – and premiums may be adjusted to the current age for the now split coverage. Transferring of a joint policy to one partner will require a legal document to be completed and shared with the insurance company.

Splitting of joint whole life coverages can however be more complex. A whole life insurance policy is one with a guaranteed payout upon death, regardless of when the insured individual dies. The policy typically includes a cash value that increases with every dividend payment. Thus, one can attach a cash value to a permanent life insurance policy. If you or your partner’s permanent life policy has a significant cash value, then it’s definitely an asset to discuss during the settlement.

Splitting a whole life policy with its associated cash surrender value is generally considered a taxable event, except when a policy is being split due to a marriage/common-law relationship breakdown.

Alternatively, the spouses may want one of the partners to take over the joint policy in return for a financial consideration. This may make greater financial sense as purchasing new policies to replace the coverage will be much more expensive if several years have passed since the original policy was purchased. However, in such a case, the new owner of the policy will be responsible to make the payments.

How to change your beneficiary post a divorce

If you’ve set your ex-partner to receive the death benefit from your insurance policy, a divorce won’t automatically change this. To change your beneficiary after separation, you have to go through your insurance company or speak with your advisor of record. However, there may be a few things for you to consider as you go about making the change.

Revocable versus irrevocable beneficiaries

Before you can change your beneficiary, you should consider whether your existing life insurance policy is “revocable” or “irrevocable”. 

  • A revocable policy means you can change the beneficiary without first consulting them. That is, if after the divorce, you want to reassign the death benefit away from your former spouse and to another person, a revocable policy allows the reassignment without informing your ex-partner.
  • In contrast, an irrevocable policy requires your ex-partner’s consent to approve the change. 

With that said, if you and your former spouse have one or multiple children together and they remain as the children’s primary caregiver, it may be best to keep your former partner as the beneficiary to ensure your children’s financial stability, in case of your death. 

How much life insurance do I need after a divorce?

As a newly single person, you should reassess how your life insurance needs have changed after a divorce. Your new life insurance needs will depend on your portion of the liabilities and how much support you have access to or would be receiving. 

Also take into account whether or not you have the responsibility to take care of the children you may have had with your former partner, provide for their education, and help maintain their lifestyle post divorce. 

It’s important to secure any new post-divorce life insurance coverage as soon as possible. Not only may the coverage be a pressing stipulaiton of your divorce agreement, if something happens to you and the expected coverage is not in place, your death could produce a complicated financial situation that may take months or years for your loved ones to settle and erode any inheritence or wealth you had intended to leave behind.

A life insurance calculator can easily help you reassess your insurance needs. If you find you don’t have adequate coverage, you may need to speak with a life insurance broker to help you get new life insurance coverage as soon as possible.

What type of insurance should you purchase after a divorce or separation?

The type of insurance to purchase will depend on your financial circumstances after a separation. Term life insurance is often ideal after a divorce or separation if you want to maximize your coverage while working within a budget. A term life policy is less expensive than many other life insurance options. Term life insurance only provides a death benefit if you die within a specific timeframe, such as within 10, 20, or 30 years and therefore the premiums are more affordable. 

You may keep your new term life policy active for as many years as you’re responsible for spousal and/or child support payments. Once your children are a certain age, they may achieve financial independence and a policy may no longer be required. 

In contrast, a permanent life insurance policy would last for the entirety of your life. This type of policy is more expensive than a term life policy, but it may provide your ex-spouse or children with a death benefit, in many cases and increasing death benefit, regardless of when you pass away.

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Writing life insurance into your separation agreement

Life insurance is critical to consider for your separation or divorce agreement. In most cases, if child support or alimony is obligated, the court may also require the spouse paying support to have a life insurance policy in place. As the spouse that may receive alimony payments, your ex-partner’s life insurance policy can ensure that you’ll continue to receive alimony payments or an equivalent sum of money, even after their death. 

You and your partner must work together or with your respective attorneys to decide on many aspects of your post-seperation life insurance coverage, such as:

  • the amount of coverage to hold 
  • the length of coverage to put in place
  • appointing the owner of the policy 
  • designating who will make premium payments
  • the names of beneficiaries 
  • the type of beneficiary designations

If your former partner purchases life insurance with you as the beneficiary after the divorce, you may even want to specify that it’s an irrevocable policy (as mentioned above). With an irrevocable policy, they can’t unilaterally change the beneficiary without your knowledge and consent. 

Without a policy, you may alternatively write into the divorce agreement that you would have priority to your ex-partner’s estate to compensate for any spousal or child support payments. However, if there’s little to nothing left at their death, you may be out of luck. In contrast, life insurance could guarantee a payout to cover or help with remaining childcare or lifestyle expenses. 

Even if you’re the one making payments, asking your former spouse to have a policy ready can act as a financial safety net, if you end up as the sole parent to your children.

Lastly, it is important to reconcile any name changes that have occurred as a result of your divorce. If an individual took on their partner’s name or made other changes to their name when they were married but choose to go by another name post-divorce, ensure that all beneficiary documentation is updated to reflect proper first and last names.

Designating your children as the beneficiary

Instead of designating your ex-partner, you may want to consider setting your children as the life insurance beneficiary. However, this could complicate things. Many provinces don’t allow children under 18 to control the money from a death benefit. As a result, you may need to appoint a trustee for your life insurance or better still to set up a trust under your children’s name. 

Setting up a trust involves finding a reliable person to act as a trustee and drafting legal documents with a lawyer. Without a trust prepared, a court may distribute the funds to a public trustee to manage on behalf of the underage children. 

Because of these complications, it may be easier to designate your former spouse as the beneficiary. The exception is if you believe that your ex-partner won’t act in the best interest of your children once they receive the death benefit. In this situation, a trust would ensure that your death benefit is used in your children’s best interest. This is because the trustee managing the funds is legally required to make sound fiduciary decisions for your children.

Life insurance can get complex during a divorce proceeding. There may be legal or contractual requirements to purchase a life insurance policy during or after a divorce proceeding. You may also need to thoroughly consider who to designate as your life insurance beneficiary. 

Speak to one of our experienced advisors to understand what options are available after your separation. PolicyAdvisor can find you a policy that satisfies both the legal and emotional requirements relating to your circumstances.

The information provided herein is for general informational purposes only. It is not intended and should not be construed to constitute legal or financial advice.

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