How Life Insurance Works in a Divorce

Among the messy tasks that must be undertaken in a divorce, sorting out life insurance is one that often gets overlooked. In the midst of the custody battles, divvying up assets, searching for a new home, ensuring the children adjust as smoothly as possible and just generally re-acclimating to life as a single person, figuring out what to do with life insurance sometimes falls by the wayside.

However, dealing with life insurance is an important part of the divorce process. This is especially true for divorcing couples with 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 child support and alimony income, and, most importantly, ensuring that any children involved are financially protected, no matter what.

Most married people with life insurance list their spouse as the primary beneficiary. The purpose of life insurance is to protect those closest to you from financial devastation if you die and your income is lost. For a married person, no one is closer than a spouse. Having your spouse as your beneficiary ensures he can keep paying the mortgage, putting food on the table and, if applicable, raising the children without your income. Having life insurance is especially important if you provide 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; he can verify if the policy is revocable and re-designate your beneficiary.

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. (For related reading, see: How Cash Value Builds in a Life Insurance Policy.)

The cash value from a life insurance policy represents part of your net worth. 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 common divorce situation where assets are divided evenly, this means you leave the marriage with half the cash value from the policy.

Protecting child support or alimony income is especially important for the spouse who takes primary custody of the children after the divorce. The money this spouse receives in child support from the noncustodial parent is supposed to go toward feeding and clothing the children and saving for college. If the worst happens and the noncustodial parent is not around anymore, this income goes away and potentially leaves the custodial parent in a bind.

If you have custody of the kids, the most prudent way to insulate yourself from the above situation 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 leaves for college. As the custodial parent, if your ex is irresponsible or untrustworthy, you may want to own the policy and pay the premium yourself since life insurance becomes null and void if the payments lapse.

One of the biggest challenges of divorce is that it frequently turns people into single parents. Sadly, many parents find they cannot rely on their ex-spouses after they end the marriage, financially or otherwise. Divorced people in these sorts of situations become solely responsible for the care and upbringing of their children. When this happens, it is important to have an emergency plan in place. (For related reading, see: Budgeting as a Single Parent.)

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 save for college. A guardian, either a relative or someone appointed by the state, will assume the care of your children, but there are still many unknown factors in this situation.

If divorce makes you a single parent, you need adequate life insurance on yourself to protect your children. To determine the minimum benefit amount, calculate how many years you have until your youngest child turns 18 (or, if you want 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 six, a death benefit of $600,000 replaces your income until that child is 18. A $750,000 benefit sees the child through until he is 21. In an era of rapidly increasing college costs, choosing the larger benefit amount is prudent as long as the premiums are not too oppressive.

(For further reading, see: 10 Mistakes to Avoid When Divorcing Over 50.)