When a Divorce Settlement Agreement includes a requirement for life insurance, the policy has one job. It is to protect the receipt of your support payments if your ex dies.
That sounds simple. It often is not.
In most states, alimony and child support payments stop when the person paying it dies. The insurance is supposed to cover the remaining obligations, usually with a lump sum payment amount. But a policy your ex owns and controls can lapse, be cashed in, or be changed, and you may not find out until the day it matters.
There are several ways to take that risk off the table and one of those is by using a trust.
What is a trust?
A trust is a legal entity that holds an asset, in this case a life insurance policy. And a person called a trustee manages that trust under written rules.
What is a life insurance trust?
A life insurance trust is a trust that owns a life insurance policy on your ex’s life. Some lawyers call it an ILIT, which stands for Irrevocable Life Insurance Trust.
Your ex creates the trust in accordance with the terms of the Divorce Settlement Agreement. A trustee runs it. The trust, not your ex, owns the policy and collects the money when your ex dies. The trustee then pays you what the Divorce Settlement Agreement says you should get, on the schedule the agreement sets.
Why naming you as beneficiary is not enough
Many agreements do it this way. Your ex owns the policy and names you as the beneficiary. Here is what still can go wrong.
Your ex may stop paying the premiums. Premiums are the payments that keep the policy alive.
The policy can lapse or be cashed in.
Your ex can change the beneficiary. The beneficiary is who gets the money.
Your ex can lower the coverage.
You may have no way to see what is happening with the policy.
The agreement may not say what happens when your support changes.
Any one of these situations can leave you with nothing.
Why the payout can be too big
Support obligations typically decrease over time. Alimony has an end date. Children grow up. So, the total you are owed drops every year.
Because of that, some lawyers suggest decreasing term life insurance, where the death benefit shrinks as the support obligations shrinks. In theory that is smart. In practice, many insurance companies do not sell it, and the ones that do often limit how often the coverage can be reduced.
How a life insurance trust fixes that
Instead of a policy that shrinks, your ex buys a life insurance policy large enough to cover the present value of all your ex’s support obligations to you when the Divorce Settlement Agreement is signed. Your ex then transfers ownership of the life insurance policy into the trust which now owns it. The trust pays you only what is still owed to you at the time your ex dies. Anything left over goes to the other beneficiaries named in the trust.
Here is an example of how the numbers might work. Say you are owed $3,000 a month in alimony for eight years, which is $288,000, and $1,500 a month in child support for ten years, which is $180,000. Together, that totals $468,000. Typically, that amount might be rounded up to $500,000 which is the death benefit of the policy.
Now say your ex dies three years in. You have already received three years of payments. Still owed: 60 more alimony payments of $3,000, which is $180,000, and 84 more child support payments of $1,500, which is $126,000. Together, $306,000.
The trust pays you $4,500 a month for the five years when both payments overlap, which is $270,000. Then it pays you $1,500 a month for the final two years of child support, which is $36,000. The total is $306,000, the same money you would have received if your ex had lived and kept paying.
So, what happens to the other $194,000? It goes to the people the trust names, such as your children, another family member, or a charity. That extra is what your ex is buying with the larger policy: the right to decide where that remaining money goes. You get everything you were owed, on the same schedule, and nobody collects a windfall.
The question to ask: who controls the policy
If you take one thing from this article, take this one. A life insurance policy is only as good as who controls it. If your ex controls it, you are relying on your ex to keep doing the right thing for years, such as paying the premiums on time, not letting the policy lapse, not changing the beneficiaries, and keeping you in the loop with copies of the policy and proof of payments.
Questions to ask your divorce lawyer
Does your Divorce Settlement Agreement state that support payments continue after my ex dies?
Does it state who owns the policy, and does it require a life insurance trust?
What happens if the policy lapses?
Who is the trustee, and can my ex replace that person without my consent?
Who gets any money left over after I am paid what I am owed?
How do I prove that the premiums were paid on time?
Who pays the premium, and is money set aside up front, so this does not depend on my ex remembering to pay?
If money is not set aside up front, the whole arrangement still depends on your ex writing a check every year for perhaps a decade or more. That is the exact promise you are trying to stop relying on.
What a trust will not fix
A trust cannot fix a policy that is too small, a policy that has already lapsed, or an insurance company that refuses to cover your ex. It adds cost, including trustee fees and paperwork. And it must be agreed to. A judge can order your ex to carry coverage, but a judge cannot force your ex to sign an irrevocable trust.
If your ex will not agree to a trust, ask your lawyer about other ways to ensure that the coverage cannot be changed or cancelled without you knowing.
The bottom line
Life insurance in a Divorce Settlement Agreement is often treated as a detail. It is not. The difference between a policy that protects you and one that does not usually comes down to control, and control is something you can negotiate while you still have leverage during the divorce process.
Jeffrey A. Landers, CDFA®, CDLP® is the Founder and CEO of Hello Monthly Income™, LLC, a specialized nationwide insurance agency that helps divorcing people protect their receipt of alimony and child support payments with life and disability insurance.
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