What does liquidity refer to in a life insurance policy?
What is Liquidity?
Broadly speaking, liquidity refers to a person’s ability to convert assets into cash. It’s common to hear about liquidity in reference to your financial portfolio; for example, your net worth might be made up of stocks, bonds, and cash in your bank account (all liquid assets), while your house, which contributes to your overall net worth, is considered an illiquid asset because it’s difficult to quickly sell for cash.
In terms of life insurance, liquidity has to do with how easy it is for a policyholder to withdraw funds from a policy. While most policies provide a cash (aka liquid) payout to one’s beneficiaries after the policyholder’s death, some also allow liquidity while the insured person is still alive. Under these policies, the policyholder can use direct withdrawals or take loans against the cash value of their permanent life insurance policy.
Any liquidity obtained while the policyholder is alive is known as a living benefit. Life insurance policies that offer living benefits are those with a cash value and those with one or more accelerated death benefit riders, which are given to policyholders who have been diagnosed with serious (normally terminal) illnesses.
Is Life Insurance a Liquid Asset?
Yes, depending on the type of insurance! That’s because, like stocks and bonds, life insurance can be liquidated and turned into cash. Remember, liquidity has to do with converting an asset into cash. A life insurance policy is considered a liquid asset because you can, at any point, surrender your policy and receive a portion of the cash value. And for the beneficiaries, the death benefit payout is definitely liquid.
What Types of Policies Offer Liquidity?
Because permanent life insurance policies have a cash value, they can be liquidated. If you have a permanent policy (such as a universal life policy, variable life insurance, and whole life insurance), part of your monthly payments go towards the cash value, which grows tax-deferred. This is one of the reasons that permanent policies tend to be more expensive than term life insurance.
Depending on the type of insurance policy, the cash value can be used in different ways. For example, universal life insurance and variable life insurance allow you to use your accumulated cash value amount for paying premiums.
Permanent life insurance covers you throughout your life — as long as you pay your premium, of course. The cash value can be counted as an asset, and your policy’s death benefit can be used as collateral.
On the other hand, term life insurance, which covers the policyholder for a defined period of time, doesn’t allow you to accumulate cash value, so there’s nothing to liquidate. That said, several insurers will let you add a living benefits rider to your plan.
Ways to Receive Liquidity in Your Insurance Policy
There are several ways to get or borrow money from your life insurance policy, which we’ll get into. But first, a note on everyone’s favorite subject: taxes. If you withdraw cash from your life insurance policy (up to the amount of paid premiums), it’s tax-free and considered a return of premiums. That said, you should contact your life insurance agent or financial advisor to learn about any and all tax implications.
Sell Your Policy
As a policyholder, you could choose to sell your life insurance policy for more than its cash value, though it must not exceed the death benefit. The buyer would be the new beneficiary and therefore would be responsible for premium payments to continue the policy. Selling your permanent life insurance policy could help you get some cash value if you can’t afford to continue paying for the policy.
Surrender Your Policy
By surrendering your life insurance policy to the insurance company, you may be able to access cash against the policy’s full value. You need to permanently terminate your insurance coverage in exchange for your life insurance policy’s cash surrender value. If you surrender your annuity, the amount you receive is the annuity surrender value.
Take Out a Loan
If the cash value has grown enough, you can borrow money from your life insurance policy in the form of a policy loan. As long as you continue paying your premiums on time and you have sufficient cash value, you can skip the usual loan approval process — which can be a benefit of going down this route. Plus, there are no fixed repayment schedules for these types of loans.
That said, you should always talk to your insurance agent before to understand all the conditions.
And remember that a life insurance policy should not be the only asset in your portfolio. When you sell or surrender your policy, you may earn less profit than what you’ve already paid out in premiums. But, if you’ve exhausted other options, these policies can be valuable investments with low-interest rates.
Life is a wild, tricky beast, and sometimes the death benefit is needed early. You need not go gentle into that good night!
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