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January 10, 2018 Practice Points

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

By George L. Metcalfe, Jr.

The use of a life insurance policy as security for future support payments is a common and advisable method of ensuring that such obligations are secured after dissolution of marriage proceedings. In some jurisdictions, a court will even require a spouse to purchase a life insurance policy on their own life to secure future support payments. The idea behind this requirement is to ensure the payee can receive the life insurance payout when the insured dies. Thus, once the divorce proceedings are complete and the obligations of the spouses are framed, securing future support payments is paramount to the client’s interests. While the use of life insurance as a security tool is strongly encouraged, there are additional measures that should be considered when utilizing life insurance policies to provide security.

Consider the scenario 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 setup is whether the minor children will 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 administering 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.

First, the insured spouse may appoint an independent fiduciary or trusted party to manage the proceeds held in the trust for the benefit of the obligee, thereby eliminating the possibility that the funds are being managed by someone who is untrustworthy or a spendthrift ex-spouse. In some jurisdictions, there is also the ability to appoint a trust protector to oversee the management of the trust by the trustee. Thus, if the trust protector learns of any mismanagement of the trust proceeds by the trustee, the trust protector may remove that trustee and appoint a successor trustee.

Second, by titling the policy in the name of an ILIT, the beneficiary of the policy will avoid the need for the appointment of a guardian over such property if the beneficiary is a minor or ever declared incapacitated. Opening a guardianship is a costly process, where in many cases, a minor’s natural guardian will petition a court to appoint someone (usually the natural guardian) to serve as the guardian of the property for the minor child. After the guardian is appointed, the guardian will be required to file annual reports and a monthly budget that must be approved by the Court, as well as, an accounting of the guardianship assets at the close of each calendar year until the child reaches the age of majority. In most cases, the practical result is that the funds of the minor are reduced substantially due to the legally required, but inefficient use of the guardianship funds.

If the life insurance policy is held in an ILIT, the proceeds can be held in further trust for the beneficiary and managed efficiently by a fiduciary at a substantially lower cost than opening a guardianship for the property. In fact, a properly drafted ILIT should provide terms as to how the administration of the funds are to be carried out in the event of death, disability, or substance abuse by the beneficiary and in addition, may even provide provisions for the protection of the monies from spendthrifts, and the beneficiary’s creditors. Some trusts even hold the proceeds for the beneficiary until they reach a certain age in which the trust will then terminate and distribute the funds outright to the beneficiary.

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

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