When a marriage ends in dissolution, assets are divided by court order between the spouses. In California, which is a Community Property State, the character of each asset determines the division — separate property (goes to one spouse), community property (is divided 50:50 between spouses), and mixed property (where an asset has both separate and community property interests is allocated accordingly between spouses).
Assets that are mixed – such as where the community property estate and one spouse’s separate property estate each have property rights – are apportioned based on proportionate interests. For example, if an asset is forty percent the husband’s own separate property and sixty percent community property then seventy percent is allocated to the husband and thirty percent to the wife, as she is entitled to one-half of any community property asset.
Disability Insurance that is purchased to safeguard preretirement earnings is usually treated the same as earnings. That is, while a couple is married each spouse’s earnings and disability income are community property. After dissolution of marriage, any disability income that is received – just like any post marital earnings — is entirely that spouse’s own separate property. Two Important exceptions, however, may nonetheless apply.
First, if Disability Insurance is purchased while married using community property funds (such as employment earnings) with the intention of providing retirement income, then a portion of the Disability Insurance payments received after dissolution of marriage is community property; that portion is allocated equally between the spouses.
Whether the exception applies is a finding of fact for a court to make. In two landmark California cases the court found that the Disability Insurance was in fact replacing retirement income. The husband had elected to receive Disability Insurance income in lieu of fully vested and mature retirement pension.
Only the excess of the disability income over the retirement pension is treated as Disability Insurance and the balance is treated as retirement income in which the community property may have an interest.
If the court finds that the Disability Insurance is both to replace lost preretirement earnings (due to disability) and to augment retirement income the court may determine a retirement age for allocation purposes. All Disability Insurance received from that deemed retirement age forward is retirement income and is divided between the spouses based on community property law to the extent that the disability benefits were contributed while married.
The second exception is when community property funds are used during marriage to purchase a right of renewal – allowing the insured to pay reasonable premiums in the future — without which right the insured would not have been able to continue paying for the Disability Insurance after the marriage ended.
The extent of the community property’s ongoing interest after marriage is determined by the extent to which the right of renewal made the Disability Insurance premiums affordable. This follows term insurance, where a right of renewal purchased with community assets allows a spouse to continue the term insurance at affordable premiums even after a significant decline in health would otherwise have either prohibited continued insurance or made it too costly.
The foregoing two exceptions to the general rule require the spouse invoking an exception to argue that the facts and circumstances require an exception. The merits of the case must stand out from the general rule.