The Ins and Outs of Spousal Support Buyouts

A spousal support buyout is a transfer of assets (cash, retirement, home equity, etc.) instead of paying monthly spousal support payments.  A “spousal support buyout” usually refers to a complete buyout of support.  A “partial” support buyout usually refers to a transfer in addition to monthly support payments, but which reduces either the amount or duration of spousal support.

Why do people do support buyouts?

Spousal support buyouts are not real common, but they do occur and can be a good option in certain situations.  There are several reasons that people will do buyouts instead of pay monthly support.  Common reasons for support buyouts include:

  • Disentanglement.  One or both people may prefer to be completely disentangled from each other.  If people are exchanging monthly payments, it means that they remain connected financially to one another for as long as support payments are owed.
  • Finality.  Spousal support buyouts are non-modifiable whereas monthly support payments are modifiable.  If you do a complete support buyout, you know that you will never have to deal with modifications in the future.  If you do a partial support buyout, it’s still possible that support could be modified.
  • Not Enough Cashflow. Sometimes the person who owes support does not have enough cash in their budget to pay support (but they still have a support obligation).  An example would be if there is a high earner who would normally owe spousal support but who takes on a substantial amount of debt and therefore does not cash to pay support.  One way of addressing this is to do a full or partial support buyout.

Are there any other considerations?

Spousal support buyouts are technically property transfers instead of spousal support payments.  This means that the transfer is not a taxable event, i.e., the person transferring the buyout does not get to write off the transfer on their taxes and the person receiving it does not pay taxes on the transfer.  This is something that is typically very appealing from the recipient’s perspective.

To make a buyout work, though, there (obviously) must be enough assets to do it.  It’s often the case that one or both people prefer a buyout but there simply are not enough assets to make it feasible.  For example, if someone would normally owe $1,500 for 10 years, the recipient presumably is not going to agree to accept $20,000 in extra 401K assets in exchange for waiving monthly support payments.

How do partial buyouts work?

A partial support buyout can be used to reduce the amount of support owed or the duration of support owed (or both).  For example, if someone owed $2,000 per month but could only afford $1,000 per month, the agreement might be that the support recipient receives $1,000 per month but also receives more retirement or home equity to “make up” for the other $1,000.

One scenario where partial support buyouts are frequently used is when support would be “indefinite” but both parties want to make sure they are not financially connected indefinitely.  The agreement might be that support is paid until the payor retires, and instead of paying a reduced amount indefinitely, the parties decide that the recipient will receive extra assets right now to “buy out” the indefinite component of the support award.  For example, someone might pay spousal support until age 65 but transfer extra retirement or home equity right now so that support terminates at 65.

Warning: If you are doing a partial support buyout, it is very important that your judgment is very specific about how the buyout limits (or does not limit) future modifications.  For example, if someone paid a lump sum of cash to “buy out” the last 5 years of support, they would not want to end up in a situation where support ended up getting modified and the duration of support lengthened.  You can protect against this by making sure that the duration of support is non-modifiable but amount of support remains modifiable.

Are there any risks to a spousal support buyout?

The main risk to a support buyout is the fact that a support buyout is not modifiable (whereas spousal support payments are modifiable).  For example, if someone were paying monthly support payments and lost his or her job, that person could probably get the spousal support reduced (at least until they got a new job).  Since support buyouts cannot be modified, if that person transferred $100,000 in extra 401K as a support buyout and then lost their job, the support buyout could not be modified and there would be no getting the buyout back.  Another example is that if the support recipient gets remarried, it is possible (although not guaranteed) that support could be reduced or terminated.  If there had been a buyout, the buyout is final and cannot be changed even if they recipient gets remarried.

Another “risk” of support buyouts from the payor’s perspective is that he or she uses most or all their assets to fund the buyout and then is left with very few assets.  (Related to this, it’s possible that the payor just doesn’t have enough “extra” assets to do a buyout.)  This is a calculated risk by the payor, but it’s a risk nonetheless.

How do you calculate a support buyout?

To calculate a support buyout, we start by looking at how much monthly support payments would normally be if there were going to be monthly payments.  (Sometimes people will just decide on an arrangement they think makes sense without going through this analysis, but people typically go through this analysis.)

After you determine what support payments would normally be, we total the amount of all payments and then make two reductions to the total amount.  The first reduction is to account for the fact that the support recipient pays taxes on monthly spousal support but does not pay taxes on the support buyout.  For example, if the total payments were $48,000 over 4 years, the recipient might pay $12,000 in taxes on those payments and therefore the actual “value” to the recipient is $36,000.  This means that $36,000 cash is worth the same as $48,000 in monthly payments since you must pay taxes on the monthly payments but not the buyout.

The second reduction is for something called “present value”.  The basic idea behind present value is that a dollar today is worth more than a dollar received at some time in the future.  For example, would you rather have a $1,000 today or $1,000 five years from now?  Why?  There are several reasons, but the two main reasons are that if you invest $1,000 now it will be worth much more in 5 years (hopefully).  The other reason is that inflation will erode the value of money over time, so $1,000 buys more today than $1,000 will buy in the future.  An example of this is that a new car used to cost $3,000.  Today, the same type of car might cost $30,000.  That’s the result of inflation (amongst other things).

So, in the above example, if you received say, $32,000 today, it might be worth the same as $36,000 paid over 4 years.  Again, the reason why is that 1) you can invest the $32,000 over 4 years to (hopefully) end up at $36,000, and 2) it costs less today to buy goods then it will cost to buy the same goods in the future.

So to summarize the above example, $1,000 per month in spousal support for 48 months is basically the same thing as receiving $32,000 today.   This is only an example!  Round numbers have been used for simplicity.  The numbers are generally in the ballpark, but these should not be relied on as “accurate” buyout numbers. 

So now what?

This is a complicated topic, so don’t worry if it doesn’t totally make sense!  If you think that a support buyout might make sense in your situation, you should discuss it with your spouse and see if it is something he or she is open to.  Your mediator, lawyer or financial professional is available to help you do the analysis and you should not feel like you need to get it figured out yourself.

Notifying the Life Insurance Company

Judgments that contain child support, spousal support or property settlements that will be paid over time typically contain a requirement that the person who owes the money has to maintain life insurance to “insure” the support award.  Once the divorce or custody judgment has been signed by the court it will be time to notify the life insurance company.  Here is what you need to know:

Disclaimer – Use and review of this article is subject to the Disclaimer at the end of the article.

Copy of the Life Insurance Policy

First, the insured party (the party who owes the money) has to provide a copy of the applicable life insurance policy to the person who is the beneficiary (or trustee beneficiary) of the policy.  The policy document provides the beneficiary with the address and other policy information that they need.

Notification Letter

Next, the beneficiary needs to send a notification letter as well as a certified copy of the judgment to the applicable life insurance company.  A certified judgment is one that contains the court’s official seal on it.  You will need to obtain a certified copy directly from the courthouse (your lawyer or mediator can assist you with obtaining a certified copy).  You can learn more about obtaining certified copies here.

The notification letter is the part that is confusing to most people.  Here is a sample life insurance notification letter.  This resource is provided only as a sample only and cannot be used as-is.  You will need draft your own letter and tailor it to your own specific circumstances and terms of your judgment.

Do not attempt this notification process if you are represented by an attorney.  Your attorney should take care of this for you.  If you are unsure if your attorney has taken this step, be sure to ask.

Confirmation from the Life Insurance Company

The life insurance notification process is not complete until you receive a notification from the life insurance company acknowledging receipt of the judgment and that they will comply with the terms of it.  If you do not receive confirmation from the company be sure that you follow up with them until you do.

Disclaimer

  • The information in this article is provided only as a general informational resource for unrepresented parties. Nothing contained herein letter constitutes legal advice and nothing contained herein should be construed as legal advice.
  • If you are represented by an attorney, you should not attempt the life insurance notification process yourself.
  • The sample letter above is not to be used “as-is”. This is a sample only which must be modified based on the circumstances of your situation.  It is your responsibility to draft your own letter.  This sample is specifically provided as a .pdf file so that you cannot use this document.
  • The life insurance requirement is very important and there can be significant consequences if it is not done correctly. If you have any questions about the life insurance notification process you should contact an attorney.
  • Use of, or reliance upon, the sample letter is done so at your own risk. Forrest Collins accepts no liability or responsibility for your use of or reliance upon the sample letter, whether used in whole or in part.
  • This article only applies to judgments entered in the State of Oregon.

Life Insurance and Divorce

Life insurance is not something that most of us like to think about or discuss.  However, in the context of divorce it is very important and something that needs to be addressed.  While this article talks about life insurance related to divorce, the concepts also apply to unmarried parents or unmarried persons where one may owe money to the other.

The basic idea behind life insurance in a divorce is that if someone owes money to someone else – whether for spousal support, child support or a property settlement – and the person who owes the money (the payor) dies, the person who was relying on that money is out of luck.  If the payor has life insurance, the recipient is still provided for.

There are three main considerations in life insurance: How much, how long and beneficiary designation.

How much life insurance is needed?

The amount of life insurance that is needed is usually the amount of money owed to someone.  For example, if someone owed a $50,000 property settlement, then $50,000 in life insurance coverage would be needed.  One generally accepted exception to this rule is that you don’t necessarily need dollar-for-dollar coverage to insure a spousal support award.  The reason for this is that spousal support is taxable to the recipient but life insurance is not.  This means, for example, that if someone was supposed to receive $100,000 in life insurance over a period of several years, they would pay taxes on that support and so they really wouldn’t receive $100,000 – they might actually receive $75,000 after paying taxes.  In this example, then, $75,000 would be an appropriate amount of life insurance to insure the $100,000 spousal support award.  This is only an example which is offered for the purpose of better explaining the concept.  You should do your own analysis on how much insurance is appropriate in your particular situation.

When it comes to child support, the easy answer is that you should maintain the same amount as you would pay in child support over time.  However, this does not take into account the fact that if one parent passes away the other parent will have substantially increased expenses for increased childcare, now having to pay all of the expenses, etc.  For this reason, people will often “round up” and maintain more life insurance to benefit the children than you would otherwise think necessary.

How long do I have to maintain life insurance?

This answer is fairly straightforward – you need to maintain life insurance for as long as you owe money to someone, including any arrearage.  An “arrearage” means past-owed money, i.e., payments that you owed but haven’t paid.  If you owe back payments, you need to maintain life insurance until you are completely paid up.

Who is the beneficiary?

In spousal support and property settlement situations, the recipient of the money is going to be direct beneficiary of the life insurance.  The reason is fairly obvious – if someone was owed money, they should receive the life insurance.

What about for child support?

People sometimes think that their children should be the beneficiary of the parent’s life insurance policy.  They shouldn’t!  The idea is well-intentioned but a non-starter.  Consider this – what if you passed away and your 5-year-old received $250,000 and has a Hot Wheels fascination?  Do you get the idea?  The money should either go to the other parent to use for the children or should go into a trust for the benefit of the children.

People very frequently name the other parent as the direct beneficiary of life insurance when there are children involved.  The basic idea is that the other parent is now responsible for all of the children’s care and expenses and therefore should have access to the money to make necessary purchases.

If someone is not comfortable naming the other parent as direct beneficiary, then the next most common approach is to set up a trust to hold the money.  The life insurance policy will name the trust as the beneficiary.  The other parent is typically named the trustee of the trust.  One benefit of establishing a trust is that there will be specific parameters for using the money.  One of the downsides is that the person maintain the insurance has to do some estate planning to make sure this is set up properly.  (This isn’t necessarily a bad thing – you should always update your estate plan post-divorce anyways.)

Other considerations.  There are a number of other considerations in addition to those mentioned above.

What if it is too expensive?

Sometimes life insurance is cost prohibitive or not available at all.  If someone has previously had a serious health issue they may simply not be able to obtain coverage.  One way of dealing with this is to have that person leave the other person assets in their estate plan which are sufficient to “pay off” the amount owed to the recipient.

Who pays for the policy?

The generally accepted rule is that it is the responsibility of the person owing the money to maintain and pay for the life insurance.  A person who is owed money also has the right to purchase additional coverage on the payor at his or her own cost (i.e., at the cost of the person who is owed the money).

Can I change policies?

A person is typically allowed to change life insurance policies as long as the same amount of coverage is maintained and the beneficiary is notified.  A new judgment will need to be obtained which specifies the new policy information.

Conclusion.

This article covers the main considerations in life insurance, but it is not exhaustive.  You should speak with your mediator or attorney if you have additional questions regarding life insurance in the divorce context.  Once you have a signed judgment, the next step will be to submit the judgment to the applicable life insurance company.

Picking the Right Process – Uncontested Divorce vs. Kitchen Table Mediation

Despite what popular culture tells us, it is very common for people who are getting a divorce to reach their own agreements.  Typically people who reach their own agreements come up with the “big picture” agreement but still need some assistance fine tuning the details or drafting documents.  It’s at this point where one person will usually call a lawyer or mediator and say they want to do an uncontested divorce.  Although an uncontested divorce may make sense in your particular situation, kitchen table mediation should be considered as well.

Uncontested Divorce.  An uncontested divorce involves one lawyer working with one client to draft the agreement the parties have reached.  Alternatively, if no agreement has been reached, then the lawyer may work with the client to create a proposal to give to the other spouse.

The lawyer in an uncontested divorce only represents the spouse who hired him or her and cannot represent both people.  The job of the lawyer is to provide legal advice to the client who hired the lawyer and to draft the documents on his or her behalf.  Clients who call about an uncontested divorce are often disappointed to learn that one lawyer cannot represent both clients even if the clients have reached their own agreement.

You can learn more about uncontested divorce here.

Kitchen Table Mediation.  In kitchen table mediation both clients work with one mediator to fine tune the agreements they have already reached.  If the clients have not already reached their own agreements then the mediator can work with both of them to create a mutually beneficial settlement.  Once a complete agreement has been reached the mediator drafts the documents on behalf of both clients.  The mediator works with both people but does not represent either person and cannot provide legal advice to either person.

You can learn more about kitchen table mediation here.

Uncontested vs. Kitchen Table Mediation.  The main difference between these two processes is that both clients participate in the kitchen table mediation whereas only one client participates in the uncontested divorce.  One of the potential issues with an uncontested divorce is that the person who did not hire the lawyer may be concerned that the documents were drafted by “their ex’s lawyer.”  This may make the non-hiring spouse suspicious and cause them to hire their own lawyer to review the documents.  Although there is nothing wrong with this, it usually creates a certain level of mistrust and often adds more expense than the clients were planning on.

Kitchen Table Mediation tends to cost less and take less time for a couple of reasons.  First, in kitchen table mediation both clients receive the same information at the same time from a neutral source, i.e., the mediator.  Instead of getting conflicting advice, clients receive neutral information which they can evaluate for themselves.  Next, both clients get the benefit of offering input in the drafting of the judgment instead of one lawyer drafting the documents on behalf of just one person.  Since the

mediator worked with both clients it is more likely that the documents will reflect the agreement that the parties reached (versus one lawyer drafting on behalf of his or her client).

The Verdict.  If both people are willing to participate in the process then kitchen table mediation usually makes more sense than an uncontested divorce.  However, if someone is not willing to come and meet with their spouse and the mediator then an uncontested divorce may be the better option.