The liquidity of a life insurance policy can hold important financial benefits that policyholders should be aware of. The liquidity of your life insurance policy will depend on what kind of life insurance policy you have. As such, it’s important to be aware of the advantages a liquid life insurance policy can provide.
Summary
- Liquidity in life insurance refers to how easily a life insurance policy can be exchanged for cash
- Different life insurance policies have different liquidity levels
- The most liquid type of life insurance is whole life and guaranteed universal life
What Does Liquidity Refer to In Life Insurance?
The “liquidity” in a life insurance policy refers to how easy the policy can be exchanged for cash without losing its value. When it comes to life insurance, whole life and guaranteed universal life insurance are the two main policies that offer any sort of liquidity. These policies accumulate “cash value” in addition to having a death benefit.
A portion of your monthly premium goes towards the cost of the insurance and a portion goes into a cash account that receives dividends. The cash value is considered liquid because you can liquidate the cash value you have accumulated and put it to use. In addition to this, your cash value will not decline when you pull it out. This is not the same for every whole life policy.
Life Insurance Liquidity Scale
To better understand liquidity, below are some examples of liquid assets and where they fall on the liquidity scale, with 10 being the most liquid and 0 having no liquidity.
Is Life Insurance Considered a Liquid Asset
As you can see from the graph above, life insurance policies are relatively liquid depending on the type of life insurance policy you have. The other types of life insurance policies like variable life, indexed universal life, and variable universal life are lower on the liquidity scale.
This is because there is a risk of financial loss due to the fact that they have variable interest rates. These policies are often tied to the performance of certain financial instruments and stock indexes which can fluctuate in value. This poses a liquidity risk because the cash value account can decrease. If you decide to withdraw money from these types of policies, you could do so at a loss.
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Term life insurance has zero liquidity. This is because the full cost of the premium pays for the insurance. Term life insurance policies do not offer any cash value and thus don’t have any liquidity value. As such, the cost of term insurance is much less than whole life insurance.
What Types of Life Insurance Policies Have the Highest Liquidity
Generally, whole life and guaranteed universal life have the highest levels of liquidity because you get a guaranteed rate of interest. These policies usually don’t carry any liquidity risk and are the most liquid when it comes to life insurance.
Tapping into your cash value with these policies requires you to call your life insurance agent and request them to send you a check for the cash value amount. The whole process usually takes around 1 week. Overall, these policies are considered liquid but you won’t get your money as fast as you can from a checking or savings account.
Can You Take A Loan Out Against Your Cash Value?
If you don’t want to surrender the cash value in your whole life insurance policy, but want to access the funds, you have some options. The great thing about a whole life insurance policy is that you can take a loan against the cash value at a low-interest rate.
This mechanism allows you to retain and grow your cash value while tapping into your savings. Most life insurance cash value loans have a low-interest rate of around 4%.
Why is Liquidity In Life Insurance Important?
If you want a death benefit along with a savings component, a whole life policy is a great option to consider. Having a liquid life insurance policy can provide you with quick access to cash for unforeseen life circumstances. Being able to have quick access to your money can provide you with peace of mind.
Although withdrawing cash from your whole life policy reduces your death benefit, it’s a great option to have if you are in dire need of money.
Conclusion
As you can see, having liquidity in your life insurance policy is advantageous as a policyholder. Knowing which type of whole life insurance policies are the most liquid that have market-related risk is important. It can help you structure a life insurance policy that fits your risk tolerance and financial goals. If you aren’t sure which policy you are best suited for, consult with a licensed life insurance advisor that can help you out.
