Liquidity of life insurance refers to how easy it is to get cash from your policy if you needed it. There are many ways for a life insurance policy to be liquid. But not all types of life insurance have liquidity and there are trade-offs to liquidating some or all of your policy.
Liquidity is a spectrum not a binary measure. The easier it is to gain access and use the cash value of your policy the more liquid the policy is. And some life insurance policies are designed to be much more liquid than others.
Key Takeaways:
- Liquidity is a term for how easy money flows or how quickly you can convert an asset into cash.
- In life insurance, the easier it is to get cash from your policy while you are alive, the more liquid that policy is said to be.
- Only permanent life insurance has a cash value component and is liquid. Term insurance rarely has liquidity.
- The additional flexibility of permanent insurance comes with a price. Permanent insurance is typically 5 to 15 times more expensive than similar term insurance coverage.
Is Life Insurance A Liquid Asset?
A liquid asset is one that can be liquidated (aka turned into cash). Permanent life insurance has the ability to be easily liquidated. There are a few ways to gain liquidity from a permanent policy:
- Cash Value: Overtime, your permanent policy will build up a cash value account. You can make withdrawals from this account like any cash account. Many policies come with a free partial withdrawal amount, but after that you may have to pay a fee to withdraw additional money.
- Surrender Value: If you fully surrender your policy, you can receive your full cash value (net any remaining surrender fees). Additionally, when you surrender a policy you no longer have to pay premiums freeing up other income.
- Loans: Many permanent life insurance policies allow you to take a loan. The benefit of a loan is that you avoid any surrender penalties. However, you do need to pay back the loan, and it may impact your policies viability.
- Sell Your Policy: There are third-party companies that will purchase your life insurance from you. This is known as a viatical settlement.
And your death benefit is always a liquid asset to your beneficiary as a lump sum payout is made to them.
In all 5 of the above methods, you can gain liquidity from your life insurance policy. However, life insurance isn’t typically the best first option for liquidity.
Additionally, many permanent insurance policies have more than a decade of surrender charges. This is a fee you pay to take cash out of your policy.
Taking a loan against your policy requires you to pay the money back with interest. Additionally, a loan may put you at risk of lapsing and losing your coverage.
Selling a life insurance policy typically results in a low payout, unless you are in poor health, as the company purchasing your policy needs to make a return.
If you are considering using your permanent life insurance for liquidity, you should talk with a financial planner or insurance agent.
Types of Life Insurance With liquidity
There are many different types of life insurance and permanent insurance. Liquidity applies to permanent life insurance that has a cash value. The common types of permanent cash-value insurance are whole life, universal life, and variable life.
The flexibility that comes with permanent life insurance has a cost. Permanent policies typically cost 5 to 15 times more than an equivalent term life policy. A major part of the higher cost is due to a portion of your premium going to the policy’s cash value to build up that fund.
However, withdrawing the cash value can impact the policy’s ability to stay current, so you need to consider the risks of liquidating some of the cash value.
The different types of permanent life insurance all have their own way to grow cash value.
- Whole Life (WL): Cash value growth is similar to a savings account and grows at a current rate of interest. These policies also have a guaranteed minimum interest rate that sets a floor for how low the growth of your policy can be.
- Universal Life (UL): UL earns interest based on the market (ie- S&P 500 or interest rates). There are many types of UL from guaranteed UL (GUL), index UL (IUL), Variable UL (VUL), and recently index variable UL (IVUL) has been introduced.
- Variable Life (VL): VL is very market sensitive and your policies performance depends on gains and losses of the market.
Each type of life insurance has its own method of growing your cash value and differing ways to access liquidity.
Can Term Life Insurance Be Liquid?
In general, no, term life insurance is not a liquid asset. It doesn’t have any cash value to it. There are very few term products with liquidity and they tend not to be popular as adding liquidity drastically increases the premiums you need to pay.
However, term life would be considered liquid to your beneficiaries when you die as they would get the lump sum payment.
Term life also may come with a term conversion rider. These let you turn some or all of your term coverage into a permanent policy currently sold by the insurer. After you convert to a permanent product and build up cash value, you will gain some liquidity.
Additionally, you may be able to sell your term life policy to a third party for a small amount of cash. There are companies out there that buy life insurance. They will pay you for the policy, take over the premium payments, and become the beneficiary on the policy.
These companies generally purchase permanent insurance more frequently as they make most of their money on being an efficient policyholder. They have a team of people to figure out how to optimize the return on the product. There isn’t many ways to be efficient with term. Additionally, permanent life insurance has a ‘guaranteed’ payout of the death benefit as it is coverage that stays with you for life. If a company buys your term policy and you outlive the product, they would not get a death benefit which makes it less enticing for them.
But a handful of companies do buy term policies. But the amount they are willing to pay you for a term policy is low.
Should You Buy A Permanent Life Insurance Policy For Liquidity?
Having liquidity in your life insurance policy is nice. But the cost of permanent coverage is 5 to 15 times that of term coverage. Therefore, it is best for those able to pay the higher premiums and looking for an additional tax-deferred investment account.
We generally wouldn’t recommend getting a permanent product because it is more liquid. There are other assets you can purchase that have better returns and liquidity than a permanent product.
Most people don’t need the higher cost and low returns on life insurance cash value. They would be better served with term coverage and utilizing a buy term & investment the difference (BTID) strategy and using a term insurance ladder strategy. This will give the most coverage, for the least amount of premiums, and the option to convert to permanent policies later.
Alternative Forms of Liquidity In Life Insurance – Riders
A life insurance rider is just an add-on feature to your base insurance contract. Some riders come free of charge, but many have an additional fee.
The common riders for liquidity are often referred to as accelerated death benefit riders or living benefit riders.
There are many riders that can add liquidity to life insurance if you qualify. For example, disability or long-term care riders allow you to access the death benefit for qualifying disability/hospice/long-term care.
However, when you take money out of your policy with these riders, you will likely be lowering the death benefit left to your loved ones when you die. But knowing that you have additional liquidity if you get sick can be helpful and is worth it for many policyholders.
There are numerous different rider types and each company has its own version. You need to read your policy statement and see which rider you think is worth it for you.
The Final Word
Life insurance is an important part of your personal financial portfolio. It is the main asset in the protection bucket of the 5 pillars of personal finance.
It is important to have liquidity in your asset portfolio. And knowing if your life insurance policy is liquid and how to access that liquidity can be crucial if you need cash.
The easiest way to get liquidity from life insurance is through a loan or withdrawing cash value from a permanent policy. Additionally, there are riders that you can add onto your life insurance that help when you qualify. Lastly, you can always look to sell your policy to a third party company.
Which choice is right for you will depend on your individual policy and situation. It is always smart to talk to your financial advisor or insurance agent to ensure you know the benefit and risks of accessing your policy’s liquidity.
Frequently Asked Questions (FAQs):
A liquid asset is one that can be liquidated (aka turned into cash). Permanent life insurance has the ability to be easily liquidated. This is largely due to having a cash value component. Term policies typically don’t have liquidity outside of selling the policy for a small amount of money.
There are 6 common ways to get liquidity from a permanent life insurance policy. Term policies typically are only liquid if you find a company to purchase them. The 5 ways to get liquidity from life insurance are:
1) Cash Value: You can withdraw money from your cash value account.
2) Surrender Value: You can fully surrender your policy and get a check for the full cash value amount, net any surrender penalties.
3) Loans: You can take a loan against your policy.
4) Sell Your Policy: You can sell your policy, known as a viatical settlement.
5) Death Benefit: The death benefit is always liquid to your beneficiary as they get a lump sum cash payment.
6) Riders: Life insurance comes with the ability to add-on features, often for a cost. These may add liquidity to your policy if you meet the qualifications.