What Does Liquidity Refer To In a Life Insurance Policy?

Life insurance is an essential asset to long-term financial planning.

We all know that purchasing life insurance helps protect our family, providing a death benefit if the insured dies. But could your policy offer even more

This article will explain life insurance liquidity and how you can use it to obtain tax benefits and access cash when you need to.

We will cover:

Continue reading to learn what does liquidity refer to in a life insurance policy.

What does liquidity refer to, and why does it matter to a business?

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Depending on the context, it may have a different meaning, but generally, liquidity describes any asset exchanging for funds relatively quickly without losing significant value. Simply put, liquidity means how easily you can sell your investment for cash.

Business owners need liquid financial assets, as they impact the company’s availability of resources for unexpected financial obligations. This also applies to regular working individuals. The more valuable assets providing liquidity you own, the better your financial ability.

Liquid assets examples 

A highly liquid asset can be sold quickly at fair market rates in return for funds. There are different types of liquid assets, and the most prevalent are:

  • savings accounts
  • stocks 
  • US government bonds
  • short-term market securities
  • mutual funds

Assets that have no liquidity are:

  • Cars
  • Houses
  • Fine art
  • Jewelry

How much liquidity do you need?

It is generally recommended to own at least one asset with high liquidity. These assets provide you with accessible money whenever you may need it. On the other hand, you don’t want all your financial assets to be liquid. 

Financial advisors usually recommend considering a balanced approach mixing assets types to access resources in times of need, maximizing earning interest, and saving for the future. 

Life insurance liquidity and cash value

Most people think of savings or checking accounts when thinking about liquid assets, but what about insurance policies? Most permanent life insurance policies, like whole life policies, have cash value, in addition to the death benefit paid to the beneficiaries. We can say that these insurance policies provide a degree of liquidity. 

If a family is left without a death benefit, they’ll have to liquidate assets, like a retirement account to pay for lost income or cover the debt.

What is cash value life insurance? 

Cash value is a component of permanent life insurance policies that act as a savings or investment account that grows at a guaranteed interest rate and allows you to withdraw or borrow against your insurance policy, increasing your income. 

Once you have built a decent balance, you gain the ability to access the cash value to cover unpaid policy premiums, take out a loan, supplement your retirement plan, or use this cash in case of a financial emergency.

What types of life insurance offer liquidity?

Generally speaking, Whole life insurance and Guaranteed Universal life insurance offer the highest liquidity, but they cost more. Besides the death benefit, these policies include a cash value account that acts as a savings account, earns interest, and allows withdrawals. Some of these offered by mutual life insurance companies may even pay dividends.

Due to variable interest rates, some permanent life insurance policies have liquidity risk. These permanent policies are based on the stock market’s performance and other financial instruments, and as your cash account is tied to them, your balance may decrease. If you have to make withdrawals at that point, you will take a loss. 

The most popular policies with this type of risk are:

  • Variable life insurance
  • Indexed universal life insurance
  • Variable universal life insurance

Does Term life insurance offer liquidity?

Unlike permanent policies, Term life insurance offers a death benefit component and no cash value. The main goal of Term life policies is to provide the death benefit to your beneficiaries and cover final expenses and administrative costs.

Unfortunately, Term life insurance policies don’t provide liquidity and cannot be used to build cash value or pay for financial ventures during your lifetime. However, some policies allow you to convert to the Whole life policy, making Term life policies liquid.

Benefits of liquidity in a life insurance policy

A life insurance policy aims to provide a death benefit to your beneficiaries. However, permanent life insurance coverage is accompanied by the gift of long-term cash value growth. 

Here are the main pros of owning a liquid insurance policy: 

  • you don’t pay taxes on withdrawals as long as they are less than your contributions
  • you can use the cash value to pay your premiums 
  • you may sell your policy for a life settlement on the secondary market
  • you can surrender the policy for its net cash value
  • use the cash value for further investing

Tax advantages

Your cash value account grows on a tax-deferred basis, meaning it is not subject to taxes. Also, when you take a loan against your policy, the proceeds are not subject to taxes. Furthermore, when your beneficiaries receive the death benefit, they won’t be required to pay taxes on it, so your estate can be transferred to them tax-free.

Banks often purchase life insurance as a tax shelter to fund employee benefits. This is the so-called bank-owned life insurance.

Disadvantages of using life insurance as a liquid asset

Slow growth

Unfortunately, building a significant amount of cash value takes time. Generally, it takes about ten years of owning the policy to reach substantial resources. 

The life insurance industry offers policies that could build up more money in cash values in a shorter period but include market risks and higher premiums.  

Reduction of Death Benefit

The downside to making withdrawals is that the insurance company usually reduces the death benefit paid to the beneficiaries by the loan amount. Also, if someone takes out a loan against the cash value, but the death happens before paying it off in full, the owed sum will be deducted from the death benefit.

Lower Interest Rates

Whole and guaranteed universal life generally offer low interest compared to other conventional investments. However, insurance is still a suitable vessel for investing as it poses little risk for loss.

Gain financial independence with Infinite Banking

What if we told you there is a way to make better use of your life insurance policy? You can finally forget about complicated money earning schemes, hefty banking fees, and rules you can’t wrap your mind around. Achieve all of that and much more with Infinite Banking!

The Infinite Banking Concept is a unique method utilizing a Whole Life policy to finance everything you would typically finance through a bank.

The Infinite Banking Concept

The Infinite Banking Concept is based on imitating how a bank operates, building your wealth while borrowing and repaying the money held in your permanent life insurance policy’s cash value account. 

With Infinite Banking, you won’t need to depend on a third party anymore, because as a policyholder, you will become both a creditor and a lender. In a sense, you become your own bank.

Instead of borrowing from a bank, you borrow against yourself. Even though you are using that money elsewhere, your Whole life insurance policy earns dividends at the same time.

Using this Infinite Banking borrowing setup strategy, you would never have to borrow money from a bank again and deal with interest rates and banking fees. You borrow from your life insurance policy and pay yourself back over time. 

How does Infinite Banking work?

When implementing Infinite Banking, you must include:

  • Overfunding (with after-tax funds) a high cash value whole life insurance policy from a life insurance company
  • Accumulation of Cash Value (tax-deferred) throughout the years you are a policyholder of your Whole life policy.
  • Tax-Free Loans against your policy’s cash value to use for your expenditure.

The end goal is to duplicate the process as much as possible to build significant cash value for your own bank. Whether you’re aiming for a new house or retirement, implementing the Infinite Banking strategy will grant you the ability to reach your goals.

Final thoughts 

We hope this article has helped you understand the basics of life insurance and figure out which type of policy to purchase if you need more liquidity. Also, Infinite Banking can be an excellent tool for utilizing your policy in the best possible way.