What Does Liquidity Refer to in a Life Insurance Policy?

A life insurance policy's liquidity refers to the ease of obtaining funds in response to a policy. Here are some information you should know about how that process works, why that benefits you, and how it matters.

Key Takeaways

• Liquidity refers to how simple it is to convert an asset into funds. In life insurance, the term refers to the ease of converting a policy into cash.
• Policyholders may use payouts or loans to access the cash value in their permanent policies while the insured individual is alive.
• Accelerated death benefits can provide supplementary liquidity.
• Life insurance plans provide beneficiaries access to funds at the time of their death, possibly to cover their essential living expenses or funeral costs.
• Businesses can use sufficient funds from life insurance settlements to carry out operational expenses, keep on boarding new team members, or readjust organizational parameters to meet the needs of a deceased authority.

What Is Liquidity in Life Insurance?

The accessibility of funds in life insurance policies correlates to an individual's ability to cash in their policy during their lifetime or after they have passed away. Liquidity can refer to both the policyholders and beneficiaries' accessibility.

Whenever a beneficiary of a life insurance policy passes away, some kind of payout is generally made. However, living benefits may also be accessible while the insured party is alive. These policies are sometimes called liquidity-benefit policies. These types of policies are:

• The cash value of life insurance policies is not covered by life insurance benefits or riders. 
• Cash-value comparative plans with accelerated death benefits.

Generally, permanent life insurance policies have cash values, so policies can be liquidated. These plans cover the insured for their entire life, so long as payment is made on time.

If you have a permanent life insurance policy, a part of your premium accumulates within the policy and grows tax-deferred. That becomes the policy s' cash value, which may be an asset for some uses. It may also be possible for you to use your policy's cash value and its death benefit as collateral for a secured loan.

In contrast to the term life insurance plan, these sorts of life insurance policies only cover the policyholder for an agreed-upon length of time, such as 5, 10, 20, or 25 years or as much as a specific age. These policies generally do not contain cash value buildup provisions, but some insurance companies permit riders in retirement that provide liquidity.

How Policyholders Benefit From Liquidity

Besides feeling peace of mind about the guarantees that your policy sets for beneficiaries in the future, you can profit from the cash-steadiness of this policy throughout the life of your beneficiaries. One way to utilize the liquidity of your policy is to take out a gain on your death advantage and access the cash offered today. Here's how it works.

Cash Value

If you have a cash value in a permanent life insurance policy, you can receive liquidity during your life by taking out a deposit or borrowing the funds in cash. Typically, taking out more than the purchase price of your policy from your cash value is taxable.

Life Insurance With Living Benefits

As an example, suppose you held a policy of fifteen years, and it has a cash value of $125,000. You contributed $100,000 directly, and $25,000 is owing to growth. If you withdraw $115,000, the $15,000 is awarded from accrued interest.

You won t need to pay taxes on gains that result from borrowing against your cash value. There won t be a set repayment term either, though interest does accrue and is added to the loan amount. If you don t pay back the loan in full before the insured person's death, the death benefit will be reduced by the outstanding loan balance.

It is critical to bear in mind when taking out a loan against your insurance policy that your coverage could lapse if your loan repayment amount is equal to or exceeds your policy's cash value. At that time, your insurance company will likely surrender your policy and use the funds to pay off the loan. If this happens, you may experience taxes and you won’t have any funds from your insurance policy.

Life Insurance With Living Benefits

Life insurance policies without cash value still have options for liquidity via rider for living benefits or accelerated death benefit (ADB) riders, which pay out a percentage of the death benefit before the insured person passes under certain circumstances.

The funds paid to beneficiaries of an insured person who dies are given directly from the death benefit.

How Beneficiaries Benefit From Liquidity

Life insurance earnings are payable to beneficiaries upon the death of the insured. This feature provides multiple advantages to families, such as offering financial assistance upon your demise. Pay close attention to the living benefits provided by life insurance because you won't have to go it all by yourself.

During Probate

Generally speaking, life insurance policies are non-probate assets. Your beneficiaries receive the amounts immediately, so they're able to take care of expenses like mortgage payments and living costs while your estate is pending in a courtroom. Probate is a long, time-consuming, and costly process that your loved ones go through to arrange a will. Non-insurance estate assets can take a long time to finish probate proceedings, delaying access to funds for the rightful heirs.

High-Value Estates

Life insurance funds can help beneficiaries avoid liquidating their valuables or favorite family heirlooms to pay for royalty expenses of high-valued estates, include:

• Legal expenses
• Accountant fees
• Other administration costs
• Estate taxes
• Inheritance taxes

If you have a house that is worth at least $12.06 million (as of 2022), you may want to consider ways to get your taxes minimized, such as placing the policy in an irrevocable trust. Generally, doing this will decrease its inclusion in your estate for tax purposes and limit its exposure to estate tax.

Frequently Asked Questions (FAQs)

How do I tell how liquid my life insurance policy is?

Once you have worked out how liquid your life insurance policy is, contact your insurance company to find out what options you have for withdrawing from or borrowing against your death benefit.

What’s the fastest way to draw on the liquidity of a life insurance policy?

The most convenient way to access cash from a life insurance is to take out a loan or take out an withdrawal from its cash value. Realize that you will have to pay withdrawal charges if you decide to withdraw them too soon, and that a loan balance that equals or exceeds your policy s cash value may cause your insurance company to surrender your policy and use the cash value to pay off the loan.