A life insurance policy’s primary goal is to give your family financial security in the event of your passing. However, certain types of life insurance include extra features that let you access your policy’s cash value while you’re still living.
In terms of life insurance, liquidity relates to how simple it is to withdraw money from your policy. Because you can readily withdraw from or surrender life insurance policies with a cash value component, like whole life insurance, they have liquidity. The liquidity of a term life insurance policy is nonexistent.
Most people just require the basic protection that a term policy offers. For people with more complex financial needs, having liquidity in your life insurance might increase your emergency or retirement savings.
Key takeaways
- The ease with which you can turn an asset you possess into cash is known as liquidity.
- Liquidity in the context of life insurance relates to how simple it is to withdraw money from your plan while you’re still alive.
- The cash value element of perpetual life insurance is the only one that has liquidity.
- Instead of purchasing a more expensive insurance with liquidity, the majority of consumers should buy term life and invest the difference.
A liquid asset, is life insurance?
Only a small subset of life insurance products are regarded as liquid assets. Your investment account is an example of a liquid asset—something you own that can be quickly converted into cash. When distributed to your beneficiaries, the death benefit becomes a liquid asset in their possession.
If any of the following apply to your life insurance policy:
- Your policy has a cash value, and once it has increased, you can take money from it just like you would from a retirement account.
- If you no longer require permanent life insurance or cannot afford it, you may surrender the policy and get a portion of the cash value in exchange.
- You can sell your life insurance: If an elderly or gravely ill policyholder decides they no longer need their life insurance, they may be entitled to sell their policy. An alternative name for this is a viatical settlement.
What Is Liquidity, And Why It’s Important?
The liquidity of a life insurance policy is one of its key advantages. This implies that if anything unexpected happens and you require money right away, you will be able to immediately access your advantages. You may use the proceeds from your life insurance policy, for instance, to assist in covering the costs of treatment if you are given a cancer diagnosis. This is one of the key arguments in favour of getting life insurance, particularly if you have dependents who would suffer financially in the event of your passing.
Remember that not all life insurance policies are created equally when thinking about liquidity. Finding the policy that best meets your needs requires comparison shopping since some policies have greater liquidity than others. In order to know what to anticipate if something happens, you should also make sure that you are familiar with the terms of your insurance.
Consider that you are searching for a life insurance plan that offers strong liquidity. In that instance, I advise looking into policies from return of premium life insurance or permanent life insurance that allows loans against the face value and penalty-free withdrawals from the cash value.
What Determines Liquidity for Cash Value Life Insurance?
The structure of the agreement between the insured and the insurer, as well as the investments made with the growing cash reserves, determine the level of liquidity for a permanent life insurance policy.
Whole life insurance offers the most flexibility in terms of coverage options. Usually, the cash value is kept in a cash account and allowed to increase at an interest rate determined by the insurance contract. As long as certain requirements are completed, the insured has the right to withdraw the money. Similar liquidity may be offered by universal life insurance policies, but the development of cash value depends on current interest rates.
In contrast, your premiums are invested in financial market products like stocks with variable life and variable-universal life insurance policies. In comparison to other permanent life insurance policies, the cash amount you are permitted to access may increase more quickly over time. You will, however, need to sell your investment part in order to access your money. If the stocks’ value has dropped after your account bought them, the transaction can result in a loss. As a result, these policies are viewed as being less liquid than whole life.
What Use Can Liquidity Have in an Insurance Policy?
For retirees, having access to financial value might be extremely beneficial. Even the best-planned retirement budgets might suffer from rising living and healthcare costs as well as an increase in life expectancy. Cash value insurance plans can be set up to allow for one-time or recurring monthly withdrawals to cover unforeseen costs as well as retirement lifestyle objectives. Remember: The death benefit is decreased by the loan amount if loans are not repaid.
Earnings that collect in your cash-value account are tax-deferred. As long as the policy doesn’t lapse or be cancelled while the funds are still outstanding, loans made against your cash value may be exempt from federal taxes. These choices could result in significant tax savings, especially if you are in a high-income band.
Liquidity in Life Insurance: What Is It?
Life insurance policy liquidity refers to how fast and easily a policy can be converted into cash, either while the insured person is still alive or after their passing. It can apply to how easily beneficiaries and policyholders can access their money.
In general, after the insured party passes away, all types of life insurance plans should offer a liquid payout to beneficiaries. However, certain insurance plans also provide cash flow during the policyholder’s lifetime; they are referred to as “living benefits” since they allow you to access the cash value or, in some circumstances, the death benefit while you’re still alive. These policies include:
- Life insurance policies with a cash value
- Policies with a single or many accelerated death benefit riders
Only permanent life insurance plans often have cash values and can be disposed of. As long as the policyholder pays the premiums on time, these insurance policies provide lifetime coverage for the insured.
If you have a permanent life insurance policy, a portion of your monthly payment builds up and grows tax-deferred within the policy. The policy’s cash value then becomes what it is, and for some reasons, it may be considered an asset. You could also be able to use the cash value and death benefit of your insurance as security for a secured loan.
Contrarily, term life insurance policies only provide coverage for the insured for a certain time, typically five, ten, or twenty years, or until a particular age. Although most insurers forbid the accumulation of cash value under these policies, some of them permit the addition of living benefit riders that offer liquidity for the duration of the insured’s life.
How Liquidity Benefits Policyholders
You can gain from the policy’s liquidity during your lifetime in addition to the assurance that your beneficiaries will be well taken care of in the future. You can access a policy’s liquidity in two different ways while you’re still alive: by using the cash value or by receiving an advance on the death benefit. Here’s how each situation works.
Cash Value
If you own a permanent life insurance policy with a cash value, you can use the cash value as a source of liquidity by either taking a withdrawal or taking out a loan against it. A withdrawal that exceeds the amount you’ve put into the cash value through premium payments is typically subject to taxation.
For illustration, let’s pretend you’ve had a policy for 15 years with a $125,000 cash value. $100,000 was your direct contribution, and $25,000 came from growth. The $15,000 from asset growth that you withdraw if you took $115,000 is taxable.
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