Including a life insurance policy in a prenuptial agreement can be complicated. Couples need to consider how to split a policy in case of separation, possible tax implications of splitting or cashing out a policy, and beneficiary changes.
And when couples draft a prenup, considering how to split a life insurance policy isn’t top of mind. “It’s not so romantic to talk about the nuts and bolts of life [insurance],” said Linda Cartier, president of the Academy of Financial Divorce Specialists in Sudbury, Ont. “They might be talking about who’s going to pay what bills, but they usually aren’t talking about much of anything else.”
Still, a couple is at least “rational and caring” at that stage compared to when they’re separating, Cartier said.
Prenuptial and cohabitation agreements (the latter are for unmarried or common-law spouses) are essentially the same in B.C., noted Ari Wormeli, a family lawyer and partner with YLaw in Vancouver.
A permanent life insurance policy with a cash surrender value can be divided like any other asset, and its division can be specified in the agreement, he said.
A policyholder doesn’t have the option to split any single life insurance policy to insure two lives. But couples could agree, if they were to separate, to partially convert a single term policy into two current-dated policies on the original life insured, with different beneficiaries, said Ladelle Baar, assistant vice-president of product taxation and financial underwriting with Canada Life in London, Ont.
With a universal life policy, which has separate insurance and investment components, a couple could agree to split the two components, with one person as the beneficiary on the insurance portion and the other as owner of the investment, Baar said.
If a couple realizes, when drafting a prenup, that a life insurance policy can’t be split based on the contract, they could buy a second policy instead, Baar said. The two policies wouldn’t mirror each other exactly, given that the partners may be of different sexes, health conditions, and ages. However, having two policies could potentially prevent tax consequences by avoiding a sale or conversion of a single policy.
The couple should understand the possible tax implications of their prenup agreement. If a policy will be surrendered to buy two new policies, for example, the sale of the first policy could be taxable if it has cash value.
Some insurers sell joint life policies with the option to exchange such a policy for two single life policies, and policyholders should understand whether their contract includes that option, Baar said. Also, conversion to a current-dated policy could have tax implications.
“People don’t realize that they’re actually disposing of one and buying another one,” Baar said.
Beneficiary considerations could also be part of a prenup. For example, a couple could agree that at separation, one spouse gets the primary residence or liquid assets, while the other becomes an irrevocable beneficiary of a life insurance policy, Wormeli said. However, this arrangement may work only if the life insured has a short life expectancy.
Even when a prenup states that one person in the couple will become the beneficiary of a policy, the couple should make sure that the beneficiary designation is updated with the insurer, Baar said.
Also, if a policy will be transferred from one person to the other upon separation, the policyholder should ensure the policy can be transferred and is not assigned to a bank for a loan, Baar said.