what does liquidity refer to in a life insurance policy?

The main goal of a life insurance policy is to help your family financially after you die. But some types of life insurance have extra features that let you take money out of the policy while you are still alive.

Liquidity in life insurance means how easy it is to get cash from your life insurance policy. Life insurance policies with a cash value component, like whole life insurance, are liquid because you can easily take money out of them or turn them in for money. There is no cash value in a term life insurance policy.

What Does “Liquid Asset” Mean?

A liquid asset is one that can be turned into cash quickly. Cash is the most liquid asset, of course. But stocks, bonds, and certain types of investments can also be quickly and easily turned into cash.

A lot of people ask, “What are some examples of liquid assets?” This is a clear sign that people don’t know what it means to be liquid. So, let’s look at some examples.

Most people only need the simple protection that comes with a term policy. But if you have cash value in your life insurance, it can help you save more for emergencies or your retirement if you have more complicated financial needs.

How Liquidity Helps Policyholders

You can have peace of mind knowing that your beneficiaries will be taken care of in the future, and you can also use the cash value of your policy while you are still alive. There are two ways to get money out of a policy while you’re still alive: using the cash value or getting an advance on the death benefit. Here’s how it works in each case.

Value in cash

If you have a permanent life insurance policy with a cash value, you can get cash during your life by taking a withdrawal or borrowing the cash value as a loan. Most of the time, you have to pay taxes on withdrawals that are more than what you’ve put into the cash value through your premiums.

How to get money from your life insurance policy.
You can get money from your life insurance policy in a few different ways. Taking out a loan against the policy is the most common way. This means that the insurance company gives you money and you pay it back over time. Another choice is to take money out of the policy’s cash value. This is different from getting a loan because you are actually taking the money out of the policy and not borrowing it from the insurance company.

How to Get the Cash Value of a Policy

You can get the cash value of a whole life insurance policy either by taking out a loan or by giving up the policy as a whole.

Loan

A whole life policy makes it easy to get a loan because you don’t have to go through the usual credit check and bank approval process. The loan is based on the policy’s cash value and can’t be more than that. If you don’t pay back the loan and the interest on it, the insurance company will just cut the death benefit on your policy.

When you take out a loan against a life insurance policy, you don’t have to make payments every month. Also, unless the policy is a modified endowment contract (MEC), like a single-premium policy, the cash you get from the loan is not taxed. But if you give up the policy or let it lapse, you will have to pay income tax on the loan amount plus interest.

Surrender

Giving up the policy is a more extreme step. If you go this route, you won’t have a death benefit to leave to your beneficiaries, and depending on how long the policy has been in effect, the surrender value may be less than the premiums you’ve paid into the policy. Also, any money you get from the policy after you give it up will be taxed as income.

Different kinds of life insurance that offer cash value
Permanent life insurance policies with a cash value part, like variable, universal, and whole life insurance, give you access to cash. Permanent life insurance is usually more expensive than term insurance, in part because some of the premiums are used to build up your cash value. Different kinds of life insurance build up cash value in different ways. These things are:

Whole life: The insurance company decides how fast the cash value grows and guarantees a minimum amount, just like a savings account.
Universal life: The interest is based on how the market index does, and the provider decides what the maximum and minimum gains can be.
Variable life: You choose where to put your money, and your gains or losses depend on how the market does.
Some types of life insurance, like variable and universal insurance, let you pay your premiums with the cash value you’ve built up. This lets you use your cash for other investments and expenses.

Lastly, you can sell your life insurance policy to get the money out of it. This means that the insurance company will give you a lump sum of money.

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