Estate Planning During a Divorce: Four Key Considerations

Takeaways

• Review and update legal documents. Divorce necessitates reviewing and updating existing legal documents such as wills, trusts, health care proxies, and powers of attorney, as well as potentially retitling jointly owned assets.
• Understand the implications on your life insurance policies. Life insurance policies are crucial during divorce, ensuring continued financial support and providing for heirs. Consider setting up a trust as the owner of the policy and ensure that you have explicitly updated the beneficiary designations with the insurance company.
• Consider trusts for financial arrangements. Revocable living trusts can be beneficial for managing alimony, child support payments, and directing funds to heirs, offering tax advantages and avoiding probate.
• Engage your estate planning attorney in the process. An estate planning attorney is essential to review the divorce settlement for any gaps, address tax implications, confirm beneficiary designations, and ensure adequate financial support for heirs.

You have planned your life carefully. With your spouse, you may have drawn up a will and established trusts to organize your estate. You likely made decisions about guardianship for your minor children should anything happen to you both before they come of age.

You have put health, life, and disability insurance in place, and most likely you are each named beneficiaries on the other’s retirement plan.

The one thing you probably never planned for was divorce.

What happens to your estate plan if you are now divorcing? Here are some key strategies to make sure your wishes are protected during and after the process of separation and divorce.

1. Understand changes you need to make to your legal documents now that you are getting divorced.

The first step is to review your existing legal documents. Divorce often requires updating or revising many of them to reflect your new circumstances and to remove roles or responsibilities previously given to your spouse.

This includes your will, health care proxy, power of attorney, insurance policies, retirement plan designations, and any trusts you and your spouse may have created together.

For example, you may need to retitle jointly owned property or financial accounts. You may also need to designate a new individual to make medical or financial decisions for you if you are ever unable to do so. In addition, the terms of your divorce settlement agreement may require certain provisions, such as maintaining life insurance for the benefit of your children or dividing retirement accounts, that should be incorporated into your updated estate plan.

If you and your spouse never created an estate plan, divorce presents the ideal opportunity to put one in place for the first time.

2. Understand how life insurance works.

If you and your spouse have life insurance, it is important to understand both how the policy is maintained and what it provides. The policy owner is the one who pays the premiums, keeps the policy in force, and has the authority to change beneficiaries. During and after divorce, this distinction matters because life insurance is often used to secure financial obligations. You want to ensure that you and your family will still be provided for if your former spouse were to die unexpectedly.

Life insurance is frequently a central part of a divorce settlement because it guarantees the continued flow of alimony, child support, or both. It can also be used to secure equalizing payments, such as buying out one spouse’s share of a home. If properly structured, life insurance ensures that these financial commitments are fulfilled even if one party dies before completing the payments.

Using a trust as the owner or beneficiary of the policy can help avoid significant pitfalls. For example, minor children cannot directly receive life insurance proceeds. Without a trust, those funds may be placed under the control of your former spouse as the children’s legal guardian. A trust allows you to choose who will manage the money and to set specific provisions for its use, such as requiring that proceeds be applied toward education or other long-term needs.

It is also critical to remember that life insurance policies are contracts with third parties, and divorce alone does not change the named beneficiary. If your former spouse remains listed as the beneficiary, the insurance company will generally pay them unless you update the designation, even if state law would otherwise revoke their rights. To avoid confusion or litigation, you should always file new beneficiary designations directly with the insurance company after divorce.

3. Consider setting up a trust to handle alimony and child support, and to direct funds to your heirs.

A revocable living trust can provide structure and certainty when it comes to alimony and child support. The trust’s creator, known as the grantor, funds the trust and sets out clear instructions for how payments are to be made. This ensures that obligations are carried out consistently and reduces the risk of disputes. An additional benefit is that, upon the grantor’s death, funds in the trust can pass directly to beneficiaries without being tied up in probate, allowing for faster and more efficient distribution.

Trusts can also offer important tax and planning advantages. Federal tax reforms that took effect in 2018 significantly changed the treatment of alimony and other financial arrangements in divorce settlements.

Prior to 2019, alimony payments were generally deductible by the payer and taxable to the recipient. However, the Tax Cuts and Jobs Act of 2017 (TCJA) eliminated this deduction for divorce or separation agreements executed after December 31, 2018. Today, alimony is neither deductible by the payer nor taxable to the recipient, which has major implications for how financial settlements are negotiated.

Because these tax rules can greatly affect both short- and long-term planning, it is essential to work with a qualified tax advisor. They can help you understand how the law applies to your specific situation, minimize tax liability, maximize after-tax income, and ensure compliance with all regulations. A tax professional can also evaluate the long-term effects of different settlement structures and asset divisions, helping you and your estate planning attorney design a trust that supports your heirs and reflects your financial goals.

4. Make sure an estate planning attorney is part of your team as you navigate the divorce process.

Perhaps the most important step you can take is to include an estate planning attorney on your divorce team. Divorce attorneys focus on the division of property and financial obligations, but estate planning attorneys ensure that your legacy is preserved and your children are protected. An estate planner will review your settlement to identify any potential gaps that could cause future issues. For example:

• Are you protected from state and federal estate taxes?
• How will divorce affect your retirement account beneficiaries?
• Will you and your children have adequate financial support if your former spouse dies?
• What are your wishes for your children if you pass away while they are still minors, and who should manage their inheritance?
• Have you reviewed all beneficiary designations?
• Are there assets you would prefer to pass outside the probate process to specific individuals?

Divorce attorneys have a different set of concerns and may overlook these key considerations.

It is also important to recognize that there may be limits to how much planning you can do while the divorce is still pending. Many states impose restrictions, known as automatic temporary injunctions or restraining orders, that prevent either spouse from changing ownership of assets, altering beneficiaries, or making large financial moves without court approval.

These restrictions are designed to protect both parties during the divorce process, but they may delay certain estate planning updates until the divorce is finalized. An estate planning attorney can guide you through what changes are permissible now and what may need to wait until after the divorce decree is entered.

Lastly, consider hiring your own estate planning attorney rather than continuing with the lawyer who created a plan for you and your spouse together. Under most state laws, when couples are jointly represented, everything you tell that attorney — even in private — is not confidential from your spouse. Having your own attorney ensures your interests are fully protected and your updated plan reflects your specific needs and wishes.

Additional Reading

For further reading regarding various aspects of estate planning, check out the following articles:

• Durable Power of Attorney: A Key Estate Planning Document
• Shannen Doherty’s Estate Planning Amid Divorce
• Navigating Disputes in Probate Court
• Understanding the Common Types of Trusts
• A Useless Power of Attorney: Avoid Free Legal Documents
• Inheritance Tax: What States Have It and When It Applies