Health & Life Insurance Actuaries | Lewis & Ellis Inc.

Liquidity in Life Insurance

Life Insurance and Annuities
by Stephanie Crownhart
Liquidity in life insurance is useful in some situations.
Liquidity in life insurance is useful in some situations.

A policyholder may buy life insurance not only to provide for their family during a time of loss, but also to be a very valuable addition to their investment portfolio. Life insurance can be an effective financial instrument to provide liquidity and personal financial growth. This is especially true for those who need access to capital. For example, there are particular business situations and estate scenarios where life insurance is a great advantage to those involved. Let's dive into the reasons why liquidity is so important in life insurance.

Why does liquidity matter in life insurance?

Liquidity is known as the availability of liquid assets to a company or individual. Liquid assets are equal to the amount of cash that a business or business owner has access to at any point in time. In life insurance, liquidity is used in terms of how easily one can retrieve cash out of the policy. This is mostly used in permanent life insurance because it accumulates cash value over time.

Why life insurance?

When it comes to choosing a life insurance policy with liquidity in mind, there are a few different reasons that make this kind of liquid asset more ideal than others. Let's take a look at a few of the reasons this is the case.

In general, life insurance is a good way to remain liquid because it allows the policyholder to retrieve funds periodically and grow those funds at a predetermined interest rate. In addition, there are unique benefits for the owner of the policy, including tax advantages for the benefits as well. The cash that is deposited is not taxable.

Unlike many assets, permanent life insurance does not have certain requirements for why withdrawals are made. Most of the withdrawals that are made on the principle are considered tax-free. These advantages and tax benefits are unique to life insurance and work together to provide an efficient way to access funds and maintain liquidity for both individuals as well as businesses. Permanent life insurance is more expensive than most other kinds of insurance, but it can be well worth it for business owners and individuals who have specific financial requirements. 

As previously mentioned, we are considering permanent life insurance in this article. Keep in mind that there are different kinds of policies even within this category that can be best used for specific circumstances.

Whole life insurance provides liquidity because it holds its value in actual cash, rather than tying it up in another kind of asset. This makes a permanent whole life insurance policy the best kind for most individuals who may want to withdraw money every so often. It's important to note that a term life insurance policy does not offer liquidity because there's no cash asset component.

A professional life insurer will be able to help you build a good life insurance policy for your needs.

Accessing cash in a life insurance policy

Here are the ways to access the liquid assets that come with the life insurance policy:

Pay policy premiums.
Make a withdrawal.
Supplement retirement income.
Total surrender.
Take out a loan.

Let's take a deeper dive into each of these methods of accessing the cash value in your life insurance policy and why someone might choose this option.

Pay policy premiums

The cash value of the insurance policy grows over time because of its interest rate. You can access this liquid asset to pay off your policy's premiums. Most insurance companies offer this as an option. This could be a good option for you if your premiums are already high.

Make a withdrawal

One of the benefits of a life insurance policy with a cash asset component is that withdrawals can be made while the policyholder is still alive. This should only be done in times of need or emergencies. In this case, you can take out a portion of the cash assets. It's important to keep in mind that doing this can reduce the death benefit. Another benefit of keeping some liquid assets in life insurance is that the withdrawals are not taxed, but this is only the case if you take out less than what has been paid in.

Supplement retirement income

It's popular to use the cash value that comes with a permanent life insurance policy to boost your retirement portfolio. Since the liquidity portion of the policy grows tax-deferred, the value grows faster than it would otherwise. Before going with this option, it is important to let the interest grow and for there to be enough to make a difference in your savings.

Total surrender

When a policyholder surrenders the policy, they get all the cash value that has grown over the time period that it was active. This is a serious step, and should only be done in the event of a serious requirement for cash. Note that by surrendering a life insurance policy in exchange for the associated cash, you give up the death benefit. In addition, there may be fees charged when a surrender happens. This is usually paid through the cash asset itself and any money that you get will be taxed if it's above what you had originally put into the insurance policy.

Take out a loan

You can look at this as "borrowing" money from the policy, which is essentially borrowing money from yourself. The loan amount remains tax free, however, the amount does accrue interest. As with the other options listed above, the amount of money that you borrow plus accrued interest will be deducted from the death benefit when you pass away.

These are a few different ways that you can access the cash value of your permanent life insurance. Speak with a professional to learn more options, and which one is best for your particular situation and needs.

Personal and estate liquidity

A life insurance policy has many different benefits aside from providing for your family and loved ones after you are gone. You can build your personal net worth, which allows you to grow with your policy. Here are some examples of permanent life insurance policies that offer a cash value component:

  • Whole life insurance: This policy may offer a fixed premium as well as a guaranteed death benefit.
  • Universal life: A universal life insurance policy is more flexible than other options. You can adjust the death benefit and reduce premiums if you need.
  • Guaranteed issue life insurance: This is a kind of whole life insurance that offers small coverage amounts. The best reason to get this kind of insurance is that you can not be rejected for it.

Whether a policyholder is adding it to a business or personal portfolio, a major benefit of having some liquidity in a life insurance policy is the tax benefits. This is only the case if the amount accessed is less than what was initially used as the premium. For example, if the total premium that was paid was $20,000 and you take out $22,500, you'll be taxed on $2,500. In addition to the policyholder being able to receive the cash value, the beneficiaries can also find an advantage to having some liquid assets in life insurance. Because the cash is immediately available, a survivor would be able to get the money they need without selling other assets.

The same is true for estate liquidity needs. Because the proceeds from life insurance are tax-free, they can be used to offset settlement costs, which are often very high. The liquidity that is offered by life insurance is often used to preserve assets for future generations, a massive benefit for that estate.

When it comes to businesses, companies often use life insurance for its unique liquidity asset qualities as a way to get cash when a key person dies. A transition is often costly for the company, and a life insurance policy can help get the company through the loss of that important leader. In this case, it's more of a funding mechanism.

There are different types of policies that are built for each unique need and requirement. A business owner, the owner of a sizable estate or an individual looking to grow their investment portfolio could find benefit from adding a permanent life insurance policy to their portfolio.

Contact a Lewis & Ellis consultant today.

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