The ABCs of Life Insurance and Divorce

The effects of divorce upon the right to life insurance are often greatly misunderstood,  and many individuals don’t realize the impact that divorce has upon this asset. As such, upon death, many policies are paid in a manner which is unintended.

Divorce Supersedes Beneficiary Designations

When individuals obtain life insurance, the insurer requires that they designate beneficiaries to their policies in order to determine who should receive the proceeds or benefits of the policy when the insured dies.  Typically, when an insured is married, he or she names his spouse as the primary beneficiary.  Divorce changes the legal right of that spouse, as the black letter law states that when divorce occurs, the rights of that spouse are automatically extinguished and no further action need be taken.

Four Problem Scenarios

  1. Harry and Sally divorce.  Sally was the beneficiary of Harry’s $500,000 life insurance policy.  Because the divorce is amicable and Harry wishes Sally to have a good life, he leaves her as the beneficiary of his insurance policy.  Harry dies.  Knowing that he meant for her to have the insurance, Sally files a claim with the insurer.  The insurer denies same.  Sally has no right to the policy.  In order for her to have had any right, Harry would have had to restate his beneficiary designation, noting that Sally, now his “ex-spouse”, was to the beneficiary.
  2. Harry and Sally divorce under the same circumstances.  However, the insurer, not knowing of the divorce, or for some other inexplicable reason, pays the claim.  The contingent beneficiaries are entitled to these funds.  However, Sally doesn’t want to pay them over.  In order to get them, they have to file a lawsuit against her and/or the insurer.  Even if they recover, the cost of legal fees and time will be significant.
  3. Harry and Sally divorce.  As part of their Property Settlement Agreement, Sally is to receive $500,000 when he dies and same is to be secured through his insurance.  Shortly after the divorce, Harry remarries.  He changes the beneficiary of his insurance to his new wife, Floozy.  He dies.  Floozy gets the money. Sally is entitled to it, but has to file an action against Floozy and Harry’s estate to recover.  Once again, more legal fees and time.
  4. My favorite (said with sarcasm): Harry and Sally divorce.  As part of the Property Settlement Agreement, Harry obtains a $500,000 policy, of which Sally is the beneficiary, so that she can have money to take care of their three young children.  I have always had two concerns with this approach.  First, if Sally doesn’t handle money well, there is no assurance that the funds will be used for the children.  Second, let’s assume Sally is a great money manager with impeccable integrity.  Several years after the divorce, she marries Bob.  Harry dies first and she receives $500,000 in cash. Sally subsequently dies while the children are still young or gets divorced from Bob.  Bob may get some or all of these funds, which is certainly not a desired result.  A trust for the benefit of the children would have been a better plan.

In short, upon divorce, it is imperative that one evaluate his or her estate plan.  Frankly, it should be done contemporaneously with the initiation of the divorce proceedings. In doing so, the manner in which life insurance is distributed will properly effect the intent of the insured in a pragmatic manner which conforms with his or her legal obligations.


Tags: , ,

About the Author

Post a Reply

Your email address will not be published.

This site uses Akismet to reduce spam. Learn how your comment data is processed.