By Charles F. Vuotto, Jr., Esq. Stephen R. Urbinato, Esq. and Scott K. Schroeder
The requirement that a payor spouse maintain a life insurance policy to secure his support obligations to the payee spouse and/or child of the marriage has become a common “boiler plate” provision of almost all Marital Settlement Agreements (hereinafter “MSA” or “agreement”). Ample authority exists for the implementation of such a provision.[i] However, the ease with which practitioners routinely insert this provision into countless agreements belies the actual complications and pitfalls that may arise if the life insurance provision is not appropriately constructed within the terms of the agreement. Through highlighting some of the most egregious errors commonly found in the life insurance provisions of settlement agreements, this article will demonstrate the necessity of creating properly drafted settlement provisions in the MSA to ensure that the intent of the life insurance requirement is achieved.
This article will address various components of workable life insurance clauses to be inserted into an MSA and explain some of the drafting pitfalls to avoid. For the most part, these provisions relate to life insurance to secure child support but, in many cases, may be equally applicable to life insurance to secure alimony.
The opening clause related to life insurance to secure a husband’s child support obligation may read as follows. This provision can be easily revised to reflect the wife’s obligation as well. For purposes herein, we shall only deal with a husband’s obligation to maintain life insurance to secure child support.
Husband shall obtain and continue to maintain, on an uninterrupted basis, individually owned life insurance upon his life in the amount of $__________ allocated equally for the benefit of ________ and _________ until their emancipation. However, the death benefit may be reduced by one-_______ upon the emancipation of a child. The death benefit may also be reduced, at the Husband’s sole request, every five years by recalculating the present value of future child support and related obligations owed by the Husband (which figure must be agreed upon by the parties).[ii] Husband shall designate _________________ as the primary beneficiaries of the proceeds of the policy upon the provision that the proceeds shall be paid to ________ as trustee [co-trustees] of a trust that shall be administered by the trustee for the benefit of the children in accordance with the provisions set forth herein. Husband shall have the right to substitute or change his policy of insurance, so long as there is no interruption in the coverage and he maintains a death benefit equal to or greaterthan the amount of insurance required at the time of the substitution herein for the benefit of the children.
It is important to typically disqualify “Group” life insurance coverage as something so insecure that it cannot be considered for securing an obligation. It is also important to note how much of the death benefit relates to each child if there are multiple children. Finally, it is crucial to note when, and if. the death benefit may be reduced and when the obligation to carry insurance for a child will end. Most critically, the beneficiary is the “trustee” of the trust referred to in the MSA.
There are various reasons to provide for the insurance benefits to be held in trust by a designated trustee. First, the trust avoids having the insurance proceeds become the property of the divorced wife and thus in most cases renders the proceeds unavailable to satisfy the wife’s unpaid creditors. Second, in most instances, the trust funds will also be protected against claims against the trust beneficiaries. Third, the trust will also assure that the insurance proceeds will be preserved by the trustee and readily available to the trustee for the purpose of meeting the needs of the beneficiary children. Fourth, if the husband is concerned about potential United States (or other state) estate taxes on his estate, it is also possible to use a trust to avoid or minimize potential estate taxes.[iii]
In order to achieve the goal of avoiding or minimizing estate taxes, however, the trust must be created by the divorcing husband during his lifetime as an irrevocable trust which in turn will apply for, purchase and own the life insurance policy. The trust would pay for the insurance premiums using annual (or other) monetary gifts made to the trust for the purpose of paying the premiums.[iv] Section 2042 of the Internal Revenue Code provides that all life insurance proceeds are includable in a decedent’s estate if (1) the decedent’s estate is the beneficiary; or (2) the decedent maintained “incidents of ownership” over the estate within three years of his death. Treasury Regulation 2042-1(c)(2) defines “incidents of ownership” to include “the power to change the beneficiary, to surrender or cancel the policy, to assign the policy, to revoke an assignment, to pledge the policy for a loan, or to obtain from the insurer a loan against the surrender value of the policy, etc.”. Thus, in order to avoid the inclusion of the trust in the husband’s estate, the irrevocable trust must be properly constructed to ensure that the divorcing husband does not have any incidents of ownership to the policy.
Some MSA’s attempt to avoid utilizing a trust by simply naming the child as the beneficiary. However, this is also problematic. Statutory law prohibits minors from being the beneficiaries of life insurance proceeds. Specifically, N.J.S.A. 17B:24-2(b) provides:
Any minor not less than 15 years of age may, notwithstanding such minority, acquire ownership of and exercise every right, privilege and power with respect to or under any contract of annuity or insurance upon the life, body or health of such minor or of another person, whether or not such contract was applied for by such minor.
A minor shall be deemed competent to receive and give full acquittance for any payment made by any insurer under the provisions and options of, or under a settlement agreement arising from, any contract of annuity or insurance in which a minor has acquired any interest, or is a beneficiary as follows:
(1) As to a minor not less than 15 years of age--a payment or payments in aggregate not exceeding $2,000.00 in any 1 calendar year, or,
(2) As to a minor not less than 18 years of age--a payment or payments in aggregate not exceeding $5,000.00 in any 1 calendar year;
provided that prior to any such payment to a minor the insurer has not received at its home office written notice of the appointment of a duly qualified guardian of the property of the minor. A minor shall not be deemed competent to alienate the right to or to anticipate or commute such payment. A minor shall not by reason of his minority, be entitled to rescind, avoid or repudiate such a contract or any exercise of a right, privilege or power, or acquittance given, thereunder; except that a minor not otherwise emancipated shall not be bound by any unperformed agreement to pay, by promissory note or otherwise, any premium on any such annuity or insurance contract.[v]
If a minor child is named as a beneficiary of a life insurance policy, the proceeds will be deposited with the Surrogate and will be administered either pursuant to the applicable Uniform Gifts to Minors Act (“UGMA”) (N.J.S.A. 46:38-13 to 46:38-41) or the Uniform Trusts to Minors Act (“UTMA”), (N.J.S.A. 46:38A-52).[vi]
There are two significant consequences that arise when proceeds of a life insurance policy are administered to a minor pursuant to the UGMA. First, while assets in an UGMA account are to be used solely for the minor child's benefit, if the surviving parent is not named as the custodian, this would result in his or her loss of control over the insurance proceeds.”. Second, the potentially unemancipated child will receive the assets of the UGMA at age 18, which could lead to possibly disastrous or irresponsible use of the funds depending on the significance of the assets and the maturity level of the child. The results of these two consequences could deprive the surviving parent the ability to use the funds as he or she chooses for the child’s benefit.
The consequences are just as significant for the funds in the UTMA. As with the UGMA, the surviving parent may not necessarily be named the trustee, and the funds could be released to the unemancipated child at least by his or her 21st birthday, which was likely not an intended result by the parents at the time of the MSA.
It is equally important to designate the beneficiary of the life insurance policy correctly. The following sample language can be used as a guide when the “trust” is created by the language of the MSA:
The beneficiary designation on the policy of insurance required to be maintained by Husband pursuant to this Agreement shall read:
_______, trustee for the benefit of _________ under the terms of a Trust Agreement contained in a Marital Settlement Agreement dated the date that this document is fully executed.
It is also important to specify the powers of the trustee, the term (time period) of the trust, and the time and manner in which the trust will end. The following sample language can be used as a guide:
_____________ shall receive the proceeds of the life insurance as trustee and hold the funds in trust for the benefit of the children.
_____________, as trustee, may use so much of the trust funds, principal as well as income, even to the full extent thereof, which are needed or desirable for the proper and adequate support, health, education and maintenance of the beneficiaries of the trust. The trust shall terminate when the youngest child has attained the age of 25 years, at which time the balance of the trust funds shall be distributed equally to _________________ and ________________ without regard to any prior distributions to any child, free of trust; and if any of the children are not then living, the deceased child’s share shall be distributed to such child’s then living issue by right of representation, and if the deceased child has no then living issue, then the balance of the deceased child’s share of trust funds shall be distributed to those persons who would take under the laws of the state of Husband’s last domicile had he then died unmarried and without a will, free of trust. Nothing in this paragraph shall be construed to authorize any trustee to use the assets of the trust estate for such trustee’s own benefit.
Many practitioners believe that, by naming the payee parent as “trustee” of the life insurance proceeds, that surviving parent will have unfettered access to the funds upon the payor’s death so long as the surviving parent continues to use the funds for the benefit of the child. That belief is wrong.
Both New Jersey statute and case law prohibits a person who has a legal obligation to support a minor child from accessing that child’s trust funds under most circumstances. Specifically, our Supreme Court has declared, “it has long been held that the estate of a minor should not be charged for the support and maintenance of a minor where others are responsible to do so...”[vii] Consequently, a parent named as sole trustee of a child’s “estate” in the form of life insurance proceeds may not be able to legally access the funds of that trust to cover an expense for the child unless that parent can demonstrate that he or she is financially unable to pay for the child’s expense. Such a result frustrates the intent of the life insurance provision in the parties’ settlement agreement, which is to secure ongoing child support to cover the expenses of the child in the event of the payor’s death.
The courts of our state continue to apply the above legal principle to prohibit a financially able parent from accessing a child’s estate to pay for child related expenses. In the case of Cohen v. Cohen[viii], a former husband challenged his former wife’s actions of reimbursing herself for their child’s living expenses from an UGMA account that she had funded and created for the benefit of their child.[ix] Applying the legal principle that “the estate of a minor may not be used for his support and maintenance if those who are legally responsible for the minor have sufficient funds to enable them to fulfill their responsibilities[.]”, the appellate court found that the mother had wrongfully accessed the UGMA funds since she clearly had the financial ability to pay for the child’s living expenses herself. This was found despite the fact that the mother had funded the UGMA account with her own funds.[x] See also Coffey v. Coffey[xi], (finding that a father breached his fiduciary duties as trustee by accessing an irrevocable trust he created for the benefit of his daughters in order to pay for his youngest daughter’s college expenses); Roberts v. Roberts[xii], (father, as custodian, did not abuse his discretion in refusing to access funds in an UGMA account to pay for his child’s private school tuition); Shafer v. Shafer[xiii], (finding that a father misappropriated funds held in trust for his children by using the funds to “support the family lifestyle and for the general benefit of the children” when he was financially able to cover the expenses himself); Mottle v. Haley[xiv], (affirming the trial court’s refusal to credit custodial accounts against the obligation of the custodian to pay college expenses for the children); Katz v. Katz[xv].
In order to guarantee that the payee spouse has access to the proceeds of the life insurance policy to provide for the child’s expenses without having to first prove an inability to pay the expense themselves, it is necessary to appoint another person to serve as a co-trustee alongside the payee spouse. In other words, by appointing a co-trustee who has no legal duty to support the child, the co-trustee will be able to access the funds for the purposes set forth in the trust agreement. Of course, the co-trustee selected should be one that has a positive relationship with the surviving parent, to minimize disagreements between the surviving parent and co-trustee. Unfortunately, this strategy cannot be used within an UTMA as N.J.S.A. 46:38A-22 limits UTMA to single custodianship.
It is also important to provide for access to the life insurance policy information by the other spouse with language such as the following:
During the term that Husband is to maintain a life insurance policy in accordance with this Agreement, he shall not hypothecate, pledge, borrow against or encumber the life insurance policy, and shall at all times keep the premiums current and the policy in good standing. Husband shall, upon reasonable request, provide Wife with proof that such insurance has been continued in good standing. The obligation of Husband to maintain the life insurance policy and the said beneficiary designation provided above shall terminate upon the emancipation of all children (although he may reduce the death benefit as stated above) so long as all support payments are current. Husband, shall execute appropriate authorizations to be kept on file with the insurance carrier that will allow Wife to communicate directly with Husband’s insurance company as provided in this subsection and to obtain only the information relating to proof that the required insurance is in effect, that all premiums are paid current, the identity of the beneficiaries (consistent with the requirements of this MSA) amount of death benefit that is currently allocated to her as beneficiary and that no liens, loans or encumbrances are against the policy. Husband shall also execute appropriate authorizations with the insurance carrier for Wife to receive duplicate mailing notices for premiums due, lapse pending and policy lapse. Additionally the Insurance Carrier issuing the policy used to secure these obligations, must be able to accommodate both the authorizations required to allow Wife to communicate with the carrier directly at any time by phone or in writing and to receive the duplicate mailing notices as described above for the policy to be considered suitable as security for these obligations. By his signature on this Agreement, Husband intends to gives his authorized consent to Wife to contact directly Husband’s insurance company for verification of the existence of the required insurance and beneficiary designation, and authorizes the insurance company to provide the information necessary to corroborate the satisfaction of the provisions of this Agreement (including a copy of the application for insurance).
Be wary of unworkable provisions related to access to policy information by the non-insured spouse. For example, a contingent owner does not always have policy access or receive policy correspondence unless the original policy owner has died, making them the new owner. Some carriers allow for a joint owner, but this would not necessarily allow for a limited scope of access to policy information if the insured chose to reallocate a portion of the policy to a new beneficiary. Also, as the MSA is an agreement between two individuals and not the insurance carrier, the parties cannot dictate an insurance carrier’s protocol or procedures for sharing information by way of their settlement agreement.“.
When drafting an MSA that will include a “built in” trust, one may wish to address the requirement of the trustee to post a bond with the following language:
The trustee of the death benefit allocated to the children
policy referenced herein shall not be required to post a bond for his/her faithful performance as trustee and shall not be required to file a formal or judicial accounting, unless required to do so by a party in interest.
As noted above, when drafting an MSA that will include a “built in” trust, it should be made clear that it’s terms create an enforceable trust under New Jersey law with the following statement:
The above terms are intended by the parties to be considered a trust under New Jersey law and all trust law shall apply, within the terms of the trust arrangement and provisions described herein.
Lastly, it may be wise to expressly provide for the liability of the insured party’s estate in the event the required insurance is not maintained as required by the Agreement. Such language could be as follows:
Should the insured party fail to maintain the life insurance required by the above provisions and die (or if for any reason the life insurance proceeds are not paid by the insurer), the amount of life insurance to be maintained upon the insured’s death shall constitute a lien against his/her estate and the other party and children shall have a claim against the insured’s estate for the amount of the life insurance death benefit to be maintained as of the date of his/her death as provided for herein.
The above drafting suggestions will help to make sure that the MSA operates to effectuate the intention of the parties as to life insurance to secure support obligations.
Charles F. Vuotto, Jr., Esq. is Of Counsel at Starr, Gern, Davison & Rubin, PC in Roseland, New Jersey. Stephen R. Urbinato, Esq. is a Partner at Starr, Gern, Davison & Rubin, PC in Roseland, New Jersey and Scott K. Schroeder is the Managing Member of the Alimony Protection Group, LLC in Paramus, New Jersey.
[i] N.J.S.A. 2A:34-23; Grotsky v. Grotsky, 58 N.J. 354 (1971); Jacobitti v. Jacobitti, 135 N.J. 571 (1994).
[ii] If this can be a fixed and agreed upon reduction schedule it can help to prevent post judgement costs and issues down the road.
[iii] The intricacies of estate taxation are beyond the scope of this article. In general, however, under current law, the United States estate tax exemption amount is $11.7 Million per person (subject to inflation adjustments) until 2026 and $5.49 Million (subject to inflation adjustments) from and after 2026 and there is no New Jersey estate tax. Thus, absent future changes to the law, estate tax considerations will affect only large estates.
[iv] In order to qualify the monetary gifts to the trust as excludable for estate and gift tax purposes, the trust must be structured to allow the beneficiaries a temporary right to remove the gifts from the trust.
[v] N.J.S.A. 17B:24-2(b).
[vi] The UGMA was repealed, effective July 2007, and replaced by the UTMA. Under the UGMA, the funds belong to the child when the child reaches age 18. Under the UTMA, the funds belong to the child when the child reaches the age of 21, unless the trust expressly directs that the custodianship be terminated at an earlier stated age after the minor attains the age of 18.
[vii] In re Application of Conda, 104 N.J. 163, 170 (1986) (citations omitted).
[viii] 258 N.J. Super. 24 (App. Div. 1992)
[ix] Id. at 26-28.
[x] Id. at 30-31.
[xi] 286 N.J. Super. 42 (App. Div. 1995)
[xii] 388 N.J. Super. 442 (Ch. Div. 2006)
[xiii] 2005 WL 3454677 (N.J. Super. A.D.)
[xiv] 2008 WL 238505 (N.J. Super. A.D.)
[xv] 310 N.J. Super. 25 (App. Div. 1998)