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February 20, 2018 Practice Points

Tips for Using Trusts to Protect Life Insurance Proceeds and Secure Support after the Dissolution of a Marriage, Part 2

By George L. Metcalfe, Jr.

Remember the scenario from our previous Practice Point, where a life insurance policy is purchased as security for one spouse’s child support payments for their minor children, and the policy is required to list the minor children as designated beneficiaries. In addition, assume the non-insured ex-spouse is a spendthrift. In many cases, the insured party would be happy to provide financially for their children should they pass before their children reach the age of majority. However, what is not being considered in this set up is whether the minor children will actually derive the benefit of the insurance proceeds. In this scenario, there is a high chance that a guardianship would be necessary for the minor children’s property. Furthermore, there is an even higher chance that the proceeds will be in the care of the spendthrift ex-spouse, as guardian of the minor children’s property. Likewise, while the proceeds of the life insurance will cover any future child support obligations, the insured spouse has no assurances that the funds will be protected from a spendthrift spouse or the costly process of administrating a guardianship for the children’s property.

One of the most effective ways of ensuring that life insurance proceeds are protected for the children is by funding an irrevocable life insurance trust (ILIT) with the life insurance policy for the benefit of the payee of such support payments. Although ILITs are most often utilized as a tool to transfer wealth to future generations without subjecting such amounts to the estate tax, there are other practical considerations for their utilization.

The use of an ILIT provides clarity among the parties as to how the funds will be managed, while preserving the support obligation from the supporting spouse. Since the policy is held in trust and an ILIT is irrevocable in nature, the supporting spouse will not be at liberty to make any unexpected changes in the beneficiary designation on the policy. In fact, the owner of the policy will be the fiduciary acting as Trustee for the benefit of the beneficiaries of the trust. At the same time, the use of the ILIT will also allow the supporting spouse to provide for the party being supported on their terms, without giving such funds outright to the beneficiary.

Although the use of an ILIT offers significant protections on the security for support obligations mandated by courts, an ILIT can also be a helpful tool in helping previously divorced clients plan for their children in the event they should pass early or if the client plans on a second marriage. One of the most common concerns among newly divorced clients with minor children from a prior marriage is ensuring that their children will be provided for in the event of their passing and protecting assets from any potential future spouse or their children. Those concerns can be alleviated by taking out a policy and funding an ILIT for the benefit of their children.

By holding a life insurance policy in an ILIT, the client effectively accomplishes both the goal of preserving assets for their children and protecting those assets from the claims of any potential future spouse and that spouse’s children. If the policy is gifted to a trust before the second marriage, the client will no longer have control over the disposition of the proceeds from such policy, as such control will be given to a trustee. In addition, once the trust document for the ILIT is prepared and funded, the client can no longer amend or change the beneficial disposition of the assets.

Accordingly, a life insurance policy is a vital piece to protecting the interests of a newly divorced client, but securing the proceeds of such policy is equally as important. The ramifications for failing to plan for other potential events that can occur with the beneficiaries of the policy can be costly and lead to much confusion with the client’s obligations. Practitioners should consider including an ILIT in their plans for their clients whenever life insurance is involved, as such vehicle provides clarity and additional value to the client by avoiding potential conflicts that may arise in the future.

George L. Metcalfe, Jr., is an associate with Richman Greer in Miami, Florida.

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