You might encounter a confusing term or two when shopping for life insurance. One such term is life insurance liquidity. While you probably know what a liquid is — cue the cup of coffee sitting next to you — you might not understand what it means for life insurance. Here’s what you need to know.

What is liquidity (in general)?

In the financial sense, liquidity describes how quickly you can convert an asset into cash without losing value. Liquid assets are helpful if you need cash to pay the bills and want to avoid borrowing money. Instead of taking on a loan, you convert your assets into money.

The liquidity of assets varies from highly liquid to illiquid. Highly liquid financial assets include checking and savings accounts, stocks, bonds, certificates of deposits (CDs), and mutual funds. Some types of life insurance are also highly liquid. You can convert these with minimal friction and receive your funds almost instantaneously.

Illiquid assets are convertible to cash, but take more work (and potentially expense) to do so. Selling them can result in gains or losses to the asset’s value, depending on the current market for the item. You might encounter fees or penalties for accessing this money. Examples of illiquid assets include jewelry, fine art, real estate, and vehicles.

What is a life insurance policy?

A life insurance policy represents an agreement between you and a life insurance provider to pay a set amount upon your death. The money from life insurance goes to people you name as beneficiaries, such as a spouse or adult children. The recipients can use life insurance proceeds to pay for anything they need or want, like funeral expenses or paying off a mortgage.

There are two primary types of life insurance: term life insurance and permanent life insurance. Term life insurance covers someone for a specific period, typically 10, 20, or 30 years. Beneficiaries receive a payout (tax-free) should something happen to you during the set time period. While you may be able to extend coverage after the term expires, the premiums become significantly more expensive.

Permanent life insurance offers coverage throughout the policyholder’s entire life. It includes a cash value, which increases as the policyholder pays their premiums.

What is liquidity in a life insurance policy?

If your life insurance policy includes a cash value component, it’s liquid. You can obtain money from the policy if needed as it gains value. Only permanent life insurance policies have liquidity. Term life insurance does not.

There are several ways you can access cash in your life insurance policy:

  • Obtain a loan: If your policy’s cash value is large enough, your insurance company might allow you to take out a loan against the policy itself. You won’t need to go through an actual loan approval process. Instead, the agency will grant you the loan based on how much you paid in premiums. Most loans won’t require fixed repayments. You’ll instead pay it back with your regular monthly premium payments.
  • Use your policy as collateral: If you’re obtaining a loan from a separate financial institution and it wants collateral, you can use your life insurance policy. Once the bank approves your offer, you can access the cash you need.
  • Surrender your life insurance policy: If you tell your insurance company you want to give up your policy in exchange for cash, they will provide you with its current monetary value (or part of it, depending on your policy). You won’t have the policy anymore, so if you wish to maintain coverage you’ll have to purchase a new one.

What types of life insurance offer liquidity?

There are multiple types of permanent life insurance with liquidity components, including whole life, universal life, and final expense.

Whole life insurance provides policyholders with fixed premiums that remain the same throughout their lives. The policy builds cash value over time at a set interest rate. If you decide to redeem the cash value component of your whole life policy while living, you can withdraw it or take out a loan. You’ll still retain your death benefits, and the policy’s cash value will increase as you make additional premium payments or repay the loan.

Universal life insurance is similar to a whole life policy, but it provides a bit more flexibility. Most universal policies allow you to adjust your premium payments or the death benefit amounts over your lifetime as long as you stay within a specific range. Your policy’s cash value will vary depending on its interest rate or the performance of certain indices, such as the stock market.

Burial or final expense insurance provides guaranteed benefits when you die, which your survivors can use for your funeral and other related costs. Most final expense policies offer coverage up to $25,000. They might have a small cash value you can access if you need money quickly.

What are the pros and cons of a life insurance policy that offers liquidity?

Purchasing life insurance with a liquidity feature has benefits and drawbacks. Here are several to be aware of.

Benefits of life insurance with liquidity

When you buy permanent life insurance, it lasts your entire life. You won’t need to worry about purchasing another policy after a decade or two, so long as you keep paying your premiums and feel as though you have adequate coverage.

The liquidity feature of permanent life insurance allows you to access cash during your lifetime. You can pull money out when needed to cover expenses. Your survivors won’t be the only ones to see the benefits of your life insurance coverage — you can, too, while you’re still living.

There are multiple types of permanent life insurance. You can choose one according to your coverage needs and risk tolerance. For instance, if you’re comfortable with the ups and downs of the stock market, you could select a policy that ties earnings to the S&P 500 or other indices. You can also vary your coverage amount to suit your financial circumstances.

Drawbacks of life insurance with liquidity

Permanent life insurance is much more expensive than term life insurance. Even if your death benefits are the same in both types of policies, the premiums for permanent coverage will be higher. Term policies are far more affordable if you prefer to keep your insurance expenses low.

Another potential disadvantage is fees. A permanent life insurance policy with liquidity usually has various fees, which might impact how quickly you can grow its cash value. These include fund management, administration costs, and a monthly per thousand charge (coverage for obtaining medical records, among other things). They vary depending on the insurance company and policy you purchase.

Once you purchase permanent life insurance, it’s yours until you die, surrender it, or stop making premium payments. That makes it inappropriate for people who want coverage for a specific timeframe, such as when they’re financially supporting young children, paying off a mortgage, or planning to remain in the workforce.

Life insurance liquidity isn’t necessary for everyone

While carrying permanent life insurance with liquidity features has a few benefits, not everyone needs it. Permanent life insurance is more expensive than term, and your coverage needs might change during your lifetime. You might find there are other alternatives more suitable for you.

If you’re in the market for life insurance and want to keep costs low while getting the coverage your loved ones need, consider Haven Life. Haven Life offers affordable term life insurance policies with varying amounts of death benefits. Get a free online life insurance quote today.

Additional Disclosures:

Access to cash values through borrowing or partial surrenders will reduce the policy’s cash value and death benefit, increase the chance the policy will lapse, and may result in a tax liability if the policy terminates before the death of the insured.

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