Liquidity refers to the ability to access the cash value of a life insurance policy before the insured’s death. Having liquidity is an important feature for many policyholders, as it provides options to withdraw or borrow funds if needed. This article will discuss the definition of liquidity in life insurance, its importance for policyholders, ways to access liquidity, the types of policies that offer it, and key considerations when evaluating liquidity needs.
Understanding Liquidity in a Life Insurance Policy
Definition of liquidity in a life insurance policy
Liquidity in life insurance refers to the ability to access a policy’s cash value before the death of the insured. Cash value is the amount that accumulates in a permanent life insurance policy, specifically whole life and universal life policies. It is the portion that remains after accounting for the costs of insurance and other charges. Policyholders can access this cash value while the policy is still in effect through a variety of options.
Importance of Liquidity for Policyholders
Liquidity is valuable for policyholders because it provides flexibility and access to funds if needed. Reasons, why someone may want liquidity, include:
- Supplementary retirement income
- Funding college education
- Making a down payment on a home
- Starting a business
- Covering unexpected medical expenses
- Bridging a gap in income during unemployment
Having liquidity enables policyholders to access funds without having to cancel the policy and lose coverage. This can be especially useful later in life when income decreases but insurance needs remain.
Ways to Access Liquidity in a Life Insurance Policy
There are several options available to policyholders to access their cash value if liquidity is needed:
1. Policy loans
Policyholders can take out a loan against the cash value of their permanent life insurance policy. The death benefit remains intact and interest is charged on the loan. Loans are usually easy to obtain and can provide access to funds relatively quickly.
Some policies pay dividends which can be withdrawn as cash. Dividends represent the share of profits the insurance company pays to eligible policyholders. Policyholders can choose to take these dividends as cash income rather than using them to purchase more coverage.
After the first few policy years, policyholders may be allowed to make withdrawals directly from the cash value. Withdrawals permanently reduce the death benefit unless repaid, and taxes and fees may apply.
4. Selling the policy
Policyholders can sell their policy to investors through a life settlement. This early access can net policyholders a portion of the death benefit. The investor continues paying premiums and collects the death benefit upon the insured’s passing.
5. Return of premium
Some policies offer a return of premium rider that guarantees a refund of some or all premiums paid if the policy is surrendered before a certain date, providing liquidity in this manner.
Types of Life Insurance Policies That Offer Liquidity
The main types of life insurance policies that offer liquidity are permanent life insurance policies and cash-value life insurance policies.
1. Permanent Life Insurance Policies
Permanent life insurance provides lifelong protection as long as premiums are paid. It also accumulates cash value that the policyholder can access. The primary forms are whole life, universal life, and variable life.
2. Cash Value Life Insurance Policies
These are policies designed specifically to provide both death benefit coverage and cash value accumulation for liquidity. Types include universal life, index universal life, variable life, and variable-universal life.
Term life insurance policies do not offer cash value buildup or liquidity. Liquidity is also not provided by accidental death policies, critical illness plans, or other supplemental policies.
Liquidity refers to the ability to access the cash value through options like loans or withdrawals while keeping the life insurance policy active. It provides valuable flexibility and funds access if needed before death. Permanent life and cash value policies offer liquidity, making them useful for supplementing retirement income, funding education, starting a business, or meeting other needs. When shopping for life insurance, evaluate your need for liquidity access along with death benefit requirements.