In Case of Divorce, Change your Estate
Plan
In the midst of the trauma of divorce,
few couples are thinking first (or at all) about their estate planning. But it
is very important that your planning be reviewed by your team of advisers,
possibly including your attorney, your financial advisor, your insurance
professional, and your CPA. All aspects of your financial situation will be
impacted – far beyond alimony payments or the division of assets.
It’s easy to forget about insurance
policies that you’ve owned for decades, so a policy review is important. The
first consideration is whether you want your divorcing spouse to be the
beneficiary of your life insurance proceeds. Perhaps the beneficiary should be
changed to your children, for example.
However, changing the beneficiary is
not always an option. Divorcing spouses are considered to still have an
“insurable interest” in one another. In fact, if you are paying alimony and/or
child support, the court may order you to keep life insurance policies in
effect to protect those payments in the event of your death. The court could
even order you to purchase life insurance for that purpose if you don’t already
own a policy.
Ownership of the policy may also be of
concern to the judge because the policy owner controls the beneficiary
designations and cash value of the policy. It’s possible that the policy may
need to be transferred to an Irrevocable Life Insurance Trust or a trust
established to purchase a new policy.
Retirement Plan Accounts
Normally the transfer of an IRA account
to another person would be a taxable event. However, it’s not taxable if
pursuant to a divorce decree. The spouse who receives the account would become
the new owner of the IRA, subject to the normal tax rules going forward. As the
new owner of the IRA, he or she could change or name new beneficiaries.
Qualified pension plans are handled
differently. If rules are not carefully followed it could jeopardize the plan
or cause immediate taxation. Modification of the plan is achieved through a
judge’s Qualified Domestic Relations Order (QDRO) which can name the spouse as
an alternative payee. The spouse is taxed on receipt of the plan’s funds, but
the normal 10% early distribution tax does not apply. The spouse can also roll
over the proceeds of the qualified plan to his or her own IRA.
Your Home
There are beneficial rules regarding
capital gains tax that apply to your personal residence. A married couple can
exclude up to $500,000 profit in a home sale from capital gains tax if the home
was owned and used as a primary residence for at least 2 of the previous 5
years. If the property is sold after the divorce, there are several rules to
determine who qualifies as the owner to calculate the exclusion requirements.
If the husband in a divorce case
transfers his ownership interests in the home to his wife, and she later sells
it, she will only be entitled to the single person’s exclusion of $250,000
instead of the $500,000 exclusion available to married couples. It is often
better (from a tax perspective) for the couple to sell the home prior to the
divorce so they can use the full $500,000 exclusion, reduce taxes, and then
split the proceeds.
Estate Planning Documents
Besides beneficiary designations on
retirement plans and insurance policies, you’ll also need to remove the
divorcing spouse as your executor, personal representative, trustee, health
care agent, attorney under a power of attorney, and any other position of
authority over your affairs; as well as any position as beneficiary of your
estate.
Other Considerations
In the event of a divorce, there are
many other items that should be addressed by your professional advisers as well
as those mentioned above. For example, you will no longer file joint tax
returns. Each spouse may have a different investment philosophy and risk
tolerance which will require reallocating investment assets. The court could
consider an inheritance from your parents (or even an anticipated inheritance)
in determining property settlements, so you’ll want to put protections in place
for that.
Further complicating things is the fact
that you may not be able to keep your same advisers – just when you need them
most. They may be prevented from working with one or both spouses because of
perceived or actual conflicts of interest. It’s also possible that the advisers
really have a strong relationship with only one of the spouses, and the other
spouse would be better served by a new adviser anyway.
If
you have any questions about how to change your estate plan and how we can
help please contact the Law Office of Orlowsky & Wilson by calling
847-325-5559 or visit our website www.orlowskywilson.com for more information.
