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Penny Gusner Consumer Analyst

A spouse's right to life insurance money

Much to your surprise, you find out that someone else is the beneficiary on your spouse's life insurance policy.

As a husband or wife, don't you have an automatic right to the life insurance money?

It's a tricky question, and the answer is: It depends.

Generally, the policy owner -- who is also usually the person who pays the premiums -- can name anyone he or she chooses as beneficiary.

Besides naming a spouse as beneficiary, a policyholder could choose another family member, such as an adult child, a business partner, or even a boyfriend or girlfriend outside the marriage. There is a tax trap, however, having three different people named as the policy owner, the insured and the beneficiary.

Insurance companies don't make moral judgments about who is named as beneficiary. They simply pay out the money when the beneficiary submits a claim.

"Life insurance is a contract between the owner of the policy and the insurance carrier," says Donald Goldberg, division vice president of AEPG Wealth Strategies in Warren, N.J.

Community property states

Usually a spouse doesn't have any right to claim the life insurance money if someone else is named as beneficiary -- except in a community property state. Those states are:

  • Arizona
  • California
  • Idaho
  • Louisiana
  • Nevada
  • New Mexico
  • Texas
  • Washington
  • Wisconsin
  • Alaska and Tennessee are considered "opt-in states." Spouses can decide to opt-in and participate in the state's community-property laws.

In a community property state, both spouses own equally any income earned during the marriage and any property purchased with that income. That includes life insurance policies.

In Washington state, for instance, if a spouse uses "community property" to pay the life insurance premiums, his or her spouse has the right to a portion of the life insurance proceeds. The extent to which the life insurance is considered community property depends on the type of policy, says Karolyn Hicks, a litigator with Stokes Lawrence, a law firm in Seattle.

With term life insurance, the entire policy is considered community property -- which would give the spouse the right to 50 percent of the death benefit -- if income earned during the marriage were used to pay the most recent premium. The other 50 percent would go to the named beneficiary.

With permanent life insurance, such as whole life or universal life, the proceeds are prorated according to the percentage of premiums paid with "community" money.

For example, a man buys a whole life policy two years before he gets married. He uses his own money to pay for the first two years of premiums. He then pays the policy with income earned after the wedding to pay for another year, and then he dies. In this case, if he names someone else as beneficiary, his wife would have rights to 50 percent of one-third of the death benefit payout, Hicks says.

Excluding a spouse

What if you want to leave the entire death benefit to someone other than your spouse? That raises a variety of issues about community property rights to the policy's benefit, says Katie Groblewski, a Stokes Lawrence estate planning attorney.

Groblewski says that in certain instances it may make sense for spouses to sign a "property status agreement," which states that the life insurance policy is separate, rather than community, property. In addition, in certain cases, the insurer may require the non-insured spouse to sign a consent form to waive rights to the death benefits. The requirements to create a "property status agreement" vary from state to state.

However, without the property status agreement, a spouse's waiver to his or her community property right to half of the death benefit could be deemed a gift from that spouse to the policy beneficiary.

"This 'deemed gift' could have unintended gift or estate tax consequences to the surviving spouse," Groblewski says.

Beneficiary decisions can be complicated, particularly for blended families where there are children from more than one marriage.

"It's very important to coordinate beneficiary designations with an overall estate plan," Groblewski says. "An estate attorney is probably the one attorney every person ought to see."

Forgetting to update the beneficiary

Sometimes an ex-spouse is named as the beneficiary by mistake because the husband or wife forgot to change the beneficiary after divorce.

Some states have laws that automatically revoke beneficiary designations to ex-spouses once the divorces are final, unless the policy is part of a divorce agreement. If the insured person dies and the ex-spouse is still named as beneficiary, the proceeds go to the secondary beneficiary; if there is no secondary beneficiary, they generally go into the deceased's estate. This protects current spouses from oversights.

But those state laws are preempted if the coverage is through an employer-sponsored plan governed by federal law.

That point was underlined in a June 3, 2013, U.S Supreme Court decision, which ruled in favor of an ex-spouse over a widow in such a dispute.

Warren Hillman had a life insurance policy through work as a federal government employee worth $124,558.03 when he died in 2008 at age 66. But the beneficiary on the policy was not his wife, Jacqueline Hillman of Virginia, but rather his ex-wife, Judy Maretta, whom he divorced 10 years earlier. Hillman had forgotten to update the beneficiary.

Maretta filed a claim for the death benefit and collected the proceeds, and Jacqueline Hillman sued. Virginia law automatically revokes beneficiary designations to ex-spouses and lets the family of the deceased sue if an ex-spouse collects the proceeds as the named beneficiary.

The Federal Employees' Group Life Insurance Act, which governs Hillman's group life policy, states that the death benefit must be paid to the named beneficiary. The Supreme Court ruled that the federal law preempts Virginia's law.

"It's a very significant case," says attorney Daniel Ruttenberg, a partner at SmolenPlevy in Vienna, Va., who argued the case before the Supreme Court for Jacqueline Hillman. Federal Employees' Group Life Insurance "is the largest life insurance program by far in the world, so it affects millions of individuals."

The case emphasizes the need to review and update beneficiary designations after major life changes. Yet many people, like Hillman, neglect to do so.

"Divorce is such a hard thing to go through," Ruttenberg says. "Once everything is done you want to forget about it."

Painful consequences

But hard as it is, simple oversights can have painful consequences for loved ones later.

"Don't rely on state laws to protect you because they can't protect you in all cases," Ruttenberg says.

It pays to double-check your policies.

Goldberg says when he meets with new clients he reviews their beneficiary designations, even when clients say everything is up-to-date.

"Every once in a while, they're mistaken and an ex-spouse is named," he says.

Jason Holloway, a Stokes Lawrence family law attorney, encourages clients to communicate with their families about estate decisions and life insurance beneficiaries, although he acknowledges that's not always easy.

"You're talking about money, about dying and [in some cases] divorce." Still, he says, "I try to encourage clients to have conversations with their families."

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