HomeBlogWhat Does Liquidity Refer To In A Life Insurance Policy (Explained)

What Does Liquidity Refer To In A Life Insurance Policy (Explained)

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What does liquidity mean in insurance?

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Let me explain to you what liquidity refers to in life insurance and why it’s important!

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What Does Liquidity Refer To In A Life Insurance Policy

In life insurance, the concept of liquidity refers to how easily you can access cash from your life insurance policy.

In other words, since your life insurance policy accumulates cash value over time, your ability to tap into that cash and how quickly the cash can be made available to you is what liquidity refers to.

For example, if you have permanent life insurance where the cash value is invested in actual cash earning you interest, your life insurance policy will be very liquid.

On the other hand, if your cash value is invested in the financial markets, then you will still have liquidity but slightly less than cash investments.

The notion of liquidity can only apply to permanent life insurance policies having cash values.

If you have a term insurance policy or another type of policy that does not accumulate cash over time, then the notion of liquidity will not apply.

Although the main purpose for getting life insurance is to provide financial security to your family when you pass away, some decide to get liquid policies so they can have something to rely on in case of an emergency or to fund their retirement. 

What Does Liquidity Mean

Fundamentally, liquidity is a measure of how easily you can convert an asset into cash.

In the context of insurance, “liquidity” refers to how easy it is for a policyholder to access cash from their life insurance policy.

The notion of liquidity applies to insurance policies that have a cash component such as permanent life insurance.

Having liquidity essentially means that you can withdraw money from your policy or surrender the policy to access cash.

What Are Liquid Assets

Liquid assets are assets that you can exchange or convert easily into cash.

If you are able to convert an asset into cash quickly without losing much of its value, the asset is highly liquid.

For example, highly liquid assets are:

  • Checking accounts
  • Savings accounts
  • Stocks
  • Bonds
  • Securities
  • Mutual funds
  • ETFs

Types of Liquid Policies

Not all insurance policies offer you liquidity.

Liquidity in life insurance relates to permanent life insurance policies having a cash value.

There are different types of life insurance policies that offer liquidity, namely:

  • Whole life insurance policy
  • Universal life insurance policy
  • Variable life insurance policy

Each type of policy will help grow your cash value in a different way.

It’s important that you speak with your insurance agent to have a better understanding of what does liquidity refers to in life insurance policy that you are considering to purchase.

Most Liquid Insurance Policies

Whole life and guaranteed universal life insurance policies generally offer the highest level of liquidity within the liquid life insurance policies.

The reason why these two policies are the most liquid among the others is that the cash value of your life insurance is kept in an account similar to a savings account earning you interest.

There are other types of life insurance policies that are less liquid as they invest the cash value in financial instruments or in other instruments.

For example, variable life, indexed universal life, and variable universal life are less liquid as the cash value of the policy is not sitting in an account earning interest but invested.

If you withdraw cash when the financial markets have declined, you are essentially taking a loss and will not realize the full potential of your cash value.

Frequently Asked Questions

Let’s look at some common questions relating to what does liquidity refer to in a life insurance policy.

What Does Liquidity Mean

In general terms, liquidity is a measure of how easy it is to convert an asset into cash.

Liquidity in insurance means how easy it is for your to access cash from your life insurance policy.

Is Life Insurance A liquid Asset

Your life insurance can be considered an asset if your policy has a cash value, you can surrender the cash value to get cash, or you are able to sell your life insurance policy for cash.

If you can withdraw cash from your life insurance or surrender it for cash, then you can say that your life insurance is a liquid asset.

However, although your policy may be a liquid asset, it does not mean that accessing the cash or surrendering it will be financially beneficial for you as you usually end up earning less than what you paid into your policy.

It’s best that you speak with a financial planner or an insurance professional for advice before you make any important decisions.

Is It Worth Purchasing A Liquid Life Insurance Policy

In reality, it’s difficult to answer this question as every person’s insurance needs and financial position is different.

Since permanent life insurance costs 5 to 10 times more than term insurance and accessing the cash value of your policy during your lifetime slashes your returns, you’ll need to carefully consider your options.

For most people, paying expensive premiums and getting a low rate of return on their cash value makes permanent life insurance a bad “investment” decision.

Keep in mind, the main purpose of life insurance is not an investment but the purchase of financial security for your family when you pass away.

However, if you are comfortable paying the high premium and need a way to access some money in case of emergency or to fund your retirement, you may want to get a liquid policy.

Is A Term Life Insurance Liquid

In short, term life insurance does not provide you with any liquidity.

The reason why term life insurance is not liquid is that it does not accumulate cash or build up any cash component over time.

On the other hand, the premiums charged for term life insurance are 5 to 10 times lower than permanent life insurance.

You’ll need to weigh your options and assess your priorities to see if you want to pay less premium and have no liquidity or pay more premium but get liquidity.

Is A Liquid Life Insurance A Good Asset

The fact is that most people buy life insurance to provide their family with financial security when they pass away and not as an investment to generate returns during their lifetime.

If you are purchasing life insurance with the primary goal of purchasing financial security and having your policy as a potential asset in case of emergency, then it may be worth it for you.

Some of the benefits of owning life insurance as a secondary asset is:

  • You get certain tax benefits as your cash value grows on a tax-deferred basis 
  • You can get investment diversification for those having complex financial positions
  • You get dividend potential as some policies pay annual dividends 

However, life insurance as an asset offers some drawbacks, namely:

  • Your investment will not grow fast over time
  • If you take money out, you reduce your death benefits 
  • You get lower interest rates 

What Does Liquidity Mean In Life Insurance Takeaways 

So there you have it folks!

What does “liquidity” refer to in a life insurance policy?

What does liquidity refer to in simple terms?

In a nutshell, liquidity in life insurance refers to your ability to get cash from your policy during your lifetime.

The notion of liquidity (or the ability to get cash from a policy) can only apply to permanent life insurance as it’s a type of insurance policy that offers a savings component.

It’s important that you carefully assess your options when looking to get money from your insurance policy for an emergency or to pay for a major expense.

It’s best that you speak with a financial advisor or an insurance professional to assess your options and make an informed decision on what’s best for you.

I hope that I was able to provide you with the answer to your question what does liquidity mean in life insurance, why it’s important, and how it works.

Good luck in your quest!

Let’s look at a summary of our findings.

What Does Liquidity Refer To In A Life Insurance Policy Summary

  • Liquidity in your life insurance refers to how much money can be made available to you when you’re alive
  • The concept of liquidity only applies to permanent life insurance as they offer a cash value that can be accessed by the policyholder during his or her lifetime
  • The benefit of having liquidity is that you withdraw cash or surrender your policy for cash if you have an urgent need for cash during your lifetime or want to fund your retirement 
  • Term life insurance policies do not have a cash savings component and as a result do not have liquidity 
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