Are insurance policies generally characterized as separate or community in a Texas divorce?
Texas follows the inception of title rule in classifying the proceeds from a life insurance policy. Ownership is established by the source of funds for the initial premium. If that premium was paid before marriage or with funds clearly traceable to separate property, the policy remains separate property even though some or all subsequent premiums are paid with community funds. This means that the full value of the life insurance proceeds will be includable in the deceased spouse's gross estate for federal estate tax purposes. The surviving spouse, if not named beneficiary, has not claim to any of the proceeds. However, the community estate has an equitable claim for reimbursement in the enhanced value of the policy attributable to payment of premiums with community funds.
Ordinary value and term life insurance with guaranteed renewable and guaranteed convertible features are covered by this rule. The insured can convert the term policy to an ordinary value policy at any time. Furthermore, the insured needs no proof of insurability to renew the policy.
For example, in Estate of Cavenaugh v. Commissioner, the insured's policy was considered an option contract, and the future payments related back to the initial acquisition of the contract. The court applied the time of acquisition rule stating that the insured's subsequent actions could to convert the character of the property.
First Premium From Community Funds
If the initial premium was paid out of community funds, the life insurance policy is a community asset. One-half the insurance proceeds are includable in the deceased spouse's gross estate for federal estate tax purposes. If a third person is named beneficiary of a community owned life insurance policy, this action may be challenged by the surviving spouse under the rules governing lifetime transfers. If naming the other person is found to be a fraud on the surviving spouse, the spouse will be awarded one-half the death benefits and the named beneficiary will be entitled to receive the deceased spouse's one-half interest in the proceeds.
Note, however, that there is no basis for asserting an equitable claim for reimbursement in the policy's enhanced value if the spouse is unsuccessful in a "fraud on the spouse" challenge, because community funds were expended on a community asset. An equitable claim for reimbursement arises only if financial contributions from one estate enhance the value of another estate (i.e., community funds enhance separate property or vice versa). Contrast this result if the spouse had paid the first premium on the policy with funds from an inheritance. This would result in the policy being separate property, and as such the community estate would have an equitable claim for reimbursement in the enhanced value of the policy attributable to the payment of premiums with community funds.
Policy Acquired After Marriage But While Domiciled In Common Law State
Suppose a life insurance policy is acquired after marriage but while the couple was domiciled in a common law state, and the couple later moves to Texas. In determining the rights to proceeds at divorce, the policy is considered quasi-community property and is community.
Computation of Equitable Claim For Reimbursement
Since the insured on a life insurance policy is not required to pay the premiums, payment of premiums is not considered a discharge of debt. Thus, the use of community funds to pay life insurance premiums is measured by the enhanced value test in relation to the contribution of spousal labor to separate property.
(1) growth of a policy’s investment feature
One way to measure the enhanced value would be to measure the growth of the policy’s investment feature (i.e. the cash value). Problems arise, however when using this approach with non-cash value term insurance policies, or when both separate and community funds have contributed to the growth.
(2) Prorate according to premiums paid.
Another approach would be to prorate the proceeds in proportion to the source of the funds that paid the premiums, (i.e., if 40% of the premiums were paid from community property funds, then the equitable claim for reimbursement added tot eh community property would only be 40% of the growth). However, this proration method has been rejected by the court in McCurdy v. McCurdy, 373 SW 2d 381 (Tex.Civ. App. 1963). In this case, the court chose to apply the inception of title rule due to its inherent simplicity and in order to ensure an equitable distribution. The inception of title rule grants the spouse a right in the proceeds from the date of the policy.
