Ensuring alimony payments continue despite premature death

Dear Gabby,

My client, Sarah, is going through a divorce. Sarah and her husband, Tom, have been married for 23 years and, although she had a great career, Tom always earned more money. Under the proposed agreement, Tom is required to pay alimony to Sarah for 10 years. Sarah is counting on her alimony to meet her financial goals. What happens if Tom passes away before the end of the 10-year term?

Sam L., Texas

Dear Sam,

In most states, alimony is based on the financial needs of the recipient and the payer’s ability to pay. If the payer dies, the alimony order is terminated. One of the most effective ways to secure alimony against the risk of premature death is through life insurance.

Using insurance to secure alimony involves purchasing a life insurance policy on the payer’s (in this case, Tom’s) life with the recipient of alimony (Sarah) named as the beneficiary. This ensures that if Tom dies, Sarah will continue to receive financial support through the life insurance proceeds.

Here’s how to do it:

1. Determine the amount: Calculate the amount of life insurance coverage needed to replace Sarah’s alimony payments in the event of Tom’s death. Consider such factors as the duration of the alimony payments (10 years), Tom’s lifestyle and health, and Sarah’s financial needs.

2. Select the policy: Choose a life insurance policy that meets the coverage needs and budget. Options include term life insurance, which provides coverage for a specific period, or permanent life insurance, which offers coverage for life as long as premiums are paid.

3. Name the alimony recipient as beneficiary: As the recipient of alimony, Sarah would be named as the beneficiary of the life insurance policy. This ensures that Sarah will receive the death benefit proceeds if Tom passes away.

4. Pay premiums: Ensure that the premiums for the life insurance policy are paid regularly to keep the coverage in force. Sarah can request that the insurance company inform her if the policy is at risk of lapse due to nonpayment of the premiums.

5. Keep records: Both parties should maintain records of the life insurance policy, including the policy number, coverage amount, and contact information for the insurance company.

6. Review regularly: Review the life insurance policy annually to ensure that the coverage amount remains adequate and that the beneficiary designation has not been changed. Sarah and Tom may adjust the coverage over time to reflect the reduction in alimony due as the termination date grows near. Sarah can include language in the divorce agreement that requires Tom to provide proof of coverage at least annually.

By using life insurance to back up alimony, Tom can provide financial security for Sarah in the event of his early death to ensure that she has the funds she requires.

Dear Gabby,

I manage my client’s IRA. He is getting divorced and has agreed to give his spouse half. How do I divide the account?

Vera H., Wisconsin

Dear Vera,

Dividing an individual retirement account during a divorce involves a specific process to ensure it’s done correctly and tax-efficiently. Here’s a general overview:

Key concept: Transfer incident to divorce

• IRAs are split through a transfer incident to divorce (TID), which allows tax-free transfers between spouses.
• This is different from qualified retirement plans like 401(k)s, which use qualified domestic relations orders (QDROs).

Steps involved:

1. Agreement on the division:
   1. The divorce decree or settlement agreement must explicitly state the IRA transfer as a TID.
   1. The agreement should detail the specific account information, transfer amount, and receiving spouse’s IRA details (if already established). If the recipient doesn’t have an IRA account, they must open one.
      
2. Transferring the funds:
   Once the divorce decree is finalized, the document is submitted to the IRA custodian (the bank or financial institution holding the IRA account).

The custodian then facilitates the transfer directly between the IRAs, following the court order’s instructions.

• Tax implications: Following the TID process ensures the transfer is tax-free. Any other method of dividing the IRA (e.g., withdrawing funds and distributing as cash) could result in tax penalties.

Gabrielle Clemens is an expert on divorce financial planning and author of Marriage Is about Love, Divorce Is about Money.