Sometimes, retirees may find themselves in need of funds to cover unexpected expenses like medical illness, a higher than anticipated cost of living, and relocation costs. If this sounds like you, then you may be seeking ways to access cash from your assets.
What many retirees who have a life insurance policy may not realize is that their policy can be a source of liquidity and much-needed funds. What does liquidity refer to in a life insurance policy? The answer may be simpler than you realize, though there are things you should know if you want to make use of your policy’s liquidity potential.
Liquidity, in the context of a life insurance policy, refers to the policyowner’s ability to obtain cash from their policy while they’re still alive. Only permanent life insurance policies have liquidity because these policies contain a cash value component that accrues interest over time and can be withdrawn or borrowed against. Term life insurance policies have no cash value, so policyowners can’t extract cash from it. However, they can be sold for cash, which enables the policyowner to access liquidity by other means.
Before we continue, it’s important to define some basic life insurance policy terms:
What is life insurance?
Life insurance is an insurance policy that ensures one or more chosen beneficiaries will be financially provided for when the insured individual passes away. A permanent life insurance remains active as the policyowner pays regular premiums over the course of their life, whereas a term policy remains active as the policyowner pays premiums only during a set amount of years. In either case, once the policyowner passes away and the policy is active, the beneficiaries can file a claim to receive a lump-sum death benefit.
In addition, permanent life insurance policies, such as whole life insurance, enable the policyowner to draw money from their policy while they’re still alive because they accrue cash value.
What is liquidity?
When it comes to assets, liquidity means the ability to easily convert an asset to cash without losing significant value. These assets are not physical goods or property, such as jewelry or real estate, which can take days to weeks to months to monetize. Instead, liquid assets can yield cash immediately or quite quickly, and can include:
- Funds in a checking account
- Money market instruments such as mutual funds
- Marketable securities
- Stocks
- Bonds
What is liquidity in life insurance?
Liquidity in the context of life insurance refers to how easy it is to draw cash from your active policy. Another way to look at it: liquidity is the ability to convert all or part of a life insurance policy into cash.
Permanent life insurance policies, such as whole and universal life insurance, have cash value components that can be easily accessed, making them liquid assets. This means that the owner of a permanent life insurance policy can either sell their policy for cash or withdraw cash from it.
Conversely, term life insurance policies don’t have a cash surrender value. However, you can access liquidity in a term life insurance policy by simultaneously converting it to a permanent policy while selling your policy to a licensed life settlement provider
What types of life insurance policies offer liquidity?
Permanent life insurance policies are the only policies that offer built-in liquidity, which is why they tend to cost 5 to 15 times more than term life insurance policies.
There are three types of permanent life insurance policies and all offer liquidity:
- Variable life: the policyowner chooses funds to invest in; any gains or losses depend on market performance
- Whole life: the policy grows at a rate set by the provider with a guaranteed minimum
- Universal life: interest accrues based on market index performance, with the policy provider setting the policy value’s floor and ceiling
Isn’t life insurance a liquid asset?
Only certain kinds of life insurance policies offer liquidity, and are therefore considered liquid assets that can be easily converted into cash. In addition, once paid out to the policyowner’s beneficiaries, the death benefit is itself considered a liquid asset.
A life insurance policy is considered a liquid asset if it satisfies any one of these three conditions:
- The policy has an accumulated cash value. Funds can be withdrawn in a way similar to a retirement account.
- The policy can be cashed in. If you can’t afford or no longer need your policy, you can find how much it’s worth and sell it via a life settlement.
- The policy is surrendered. Since the surrendered policy gives the policyowner cash, it becomes a liquid asset.
What are the main advantages of a life insurance policy that include liquidity?
A life insurance policy with a cash value (which means it has liquidity) is great for those who can afford policies with high premiums and want the flexibility to dip into the policy’s cash value fund in the future. There’s no fee or tax penalty for making withdrawals. Taking out a life insurance policy with built-in liquidity gives you an additional tax-deferred investment account, which makes it easier to handle expenses that may arise unexpectedly, such as qualifying conditions from a medical emergency.
What are the main disadvantages of a life insurance policy that include liquidity?
It can take over a decade of paying the premiums on your permanent life insurance policy for it to accrue a significant cash value sum. That’s why these policies should be thought of as a high-cost long-term investment. And because it can take many years for the cash value to accrue, permanent life insurance policies aren’t the right solution if you anticipate that you may need a source of short-term funding.
Can you add liquidity to your current life insurance policy?
If you currently possess a term life insurance policy, there’s no cash value component, therefore you can’t add liquidity. However, your policy may have an option for a term conversion rider, which lets you convert some or all of your term coverage into a permanent policy with liquidity so that you can start to accumulate cash value. It’s important to note: it can take a long time to grow your investment, so this may not be the most ideal way to add liquidity.
Taking out a life insurance policy that provides liquidity can be a great way to secure your loved ones’ future and also give you the means to access cash, should you need it during your retirement.
If you have more questions about life insurance policies, visit Coventry Direct’s blog. Or, if you want to learn more about how to sell your life insurance policy, get started by clicking here!