What Does Liquidity Refer to in a Life Insurance Policy?

The liquidity of a life insurance policy refers to how quickly and easily money can be drawn from the policy. Here, learn about how this process is put into practice, who it benefits, and why it matters.

Key Takeaways

• Liquidity symbolizes how easy it is for someone to convert an asset into cash. 
• In life insurance, the term refers to how easy it is to access the money from a life policy. 
• Policyholders may make direct withdrawals or loans on the cash value in their permanent policies during the life of the insured. Accelerated death benefit riders can allow for supplemental liquidity.
• Life insurance plans monetarily benefit a beneficiary when the insured person dies, granting funds for the living or non-living costs incurred at that time. 
• Businesses can choose whether to use the funds to operating costs, make investments, or restructure the company when the insured leader passes away.

What Is Liquidity in Life Insurance?

In life insurance policies, liquidity refers to how rapidly an individual or group can convert an insurance policy into cash. This might pertain to the accessibility of funds for policyholders and beneficiaries.

Life insurance policies should provide beneficiaries with a settled cash payout just before their death. There are also some life insurance contracts which offer possessions during the lifetime of the insurance policy client. These policies are identified as living benefits because you're able to access the contract s cash value or, in some cases, the benefit payout, while you are alive. These policy ideas are called:

• A living-beneficiary aspect to a life insurance policy with a cash value. 
• Policies with increasing accelerated benefit riders may also have a cash value.

Generally, only permanent life insurance policies have cash values. With these policies, the insured is covered for their entire life as long as the policyholder keeps making timely payments.

Your premium and any ensuing growth in cash value accumulate within the life insurance policy and accumulate tax-deferred. From that point, the policy s cash value works as an asset for various uses. You can also use the policy s cash value and the death benefit as collateral for a secured loan.

In contrast to term life insurance, which provides you with coverage at a set quantity of time or up to a certain age, our life coverage provides you with coverage for a particular date and has a face value. Regardless of the veracity of this policy, the cash value does not continue to build. It is possible to add riders that offer funds throughout your life.

How Policyholders Benefit From Liquidity

In addition to knowing what the future will hold for you and beneficiaries, you can make the most of a policy's equity while you are still alive. There are two methods through which a policy's equity can be accessed while you are alive: Accessing cash value by borrowing against it and taking a loan on the death benefit. Here's how it works in each case.

Cash Value

If you have a cash value in a cash value life insurance policy and you decide to obtain a withdrawal or loan, you may be required to pay taxes on the excess amount. The amount that exceeds the payments you have made to your cash value throughout the policy is taxable.

For example, suppose you held a policy for 15 years, and it has a value of $125,000. You contributed $100,000 directly, and $25,000 is due to growth. Should you withdraw $115,000, the $15,000 from asset growth is taxable.

If you borrow against your cash value, you likely won't pay taxes on the money from the proceeds. There won't be a set repayment term either, though interest still accrues and is added to the loan principal. If you don't pay off the loan in full by the time the insured person dies, the death benefit will be reduced by the outstanding balance.

It's crucial to remember when taking out a loan against your policy that your policy may lapse if you have an outstanding loan balance that's equal to or larger than your policy's cash value. At that point, your insurance company may release your policy and use the money to pay off the loan. Because these circumstance take place, you could face tax consequences and won't receive any money from your policy.

Life Insurance With Living Benefits

Life insurance policies without a cash-value benefit can still provide liquidity through riders in the forms of riders for living benefits or accelerated death benefit (aDB) riders, which pay out part of the death benefit to the beneficiary before the insured person passes if certain conditions are met.

Important: These policies can give you a part of your cash if you suffer a specific health issue as a result of failing health. The most common types of ADBs are for:

• Chronic Illness: To qualify for consideration, you must typically be unable to accomplish at least two activities of daily living (ADLs), such as bathing and feeding yourself.
• Critical Illness: If your doctor diagnoses you with a life-threatening disease or condition, you may qualify for this policy.
• Terminal Illness: If you have a life expectancy of 6 months or over two years, you might qualify for this benefit (the amount of the duration varies between insurers).
• Long-term Care: Similar to the chronic illness rider, you will need to qualify for the settlement if you have less than two ADLs. However, it generally involves a waiting interval and provides an amount instead of a lump sum.

Usually, beneficiaries receive a reduced death benefit when the covered person has died because the cost of this rider comes from the deceased's death benefit.

How Beneficiaries Benefit From Liquidity

A life-insurance policy provides a payout to a policyholder's relatives if he passes away. One of the chief advantages of using a life policy is that life insurance gives you financial support for your family members after you pass. This is especially comforting if you would not have been able to do so otherwise. Added here are the various ways your beneficiaries can benefit from life insurance liquidity:

During Probate

In general, life insurance proceeds are considered to be non-probate assets for beneficiaries so you can quickly make use of the money to pay off mortgages and other debts or living expenses after probate has been satisfied. 

Probate is a particularly prolonged and costly procedure for a probate court to verify the will of the person who passed, and the executor distributes assets accordingly. Non-life-insurance assets from an estate can sometimes take a long time in probate, delaying access to the beneficiaries, and causing financial hardship.

High-Value Estates

Having the use of insurance policies can provide beneficiaries enough funds to avoid liquidating a valuable asset or family heirloom to pay estate expenses. Including:

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

For those who have estates that figure over the federal estate tax exemption of $12.06 million (by 2022), it’s also recommended Try out strategies to curb the number of taxes you have to pay, for instance, by putting the life insurance policy in a trust. So, doing so will usually wind up diminishing the valuation of your land and/or limiting its future exposure to inheritance and income taxes. This may be proper if your state levies inheritance and income taxes, too.

Frequently Asked Questions (FAQs)

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

One way to understand how liquid your life insurance coverage is would be to contact your insurance company. Ask them what options you have for withdrawing or borrowing against your death benefit.

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

The quickest way to access the funds in life insurance policies is to take a withdrawal or loan from their cash value. Be aware that you can pay surrender fees if you attempt to access them from the cash value early, and allowing a loan balance to match or exceed your policy's cash value may result in your financial insurance carrier surrendering the policy and using the cash value to pay off the loan.