What Is Liquidity in an Insurance Policy?

What happens when you have an emergency? Do you have a source of cash you can tap into to help you navigate through the hard times? Or will you be left stranded and have to incur more debts to deal with your problems?

Even though life is unpredictable, one in every four​ Americans doesn’t have an emergency fund of any sort. In addition, ​51 percent​ of Americans cannot cover more than three months’ worth of expenses should the unexpected happen.

And yet, 52 percent​ of Americans in the country have some kind of life insurance, and 92 percent ​of them have a health insurance plan. Clearly, if so many people have various types of life and health insurance, the issue boils down to liquidity.

Read More​: Concept of Insurance

What Is Liquidity?

Liquidity refers to how easy or difficult it will be for you to sell an asset you own for cash should the need arise. And you should be able to convert it into cash without significantly impacting its price.

Sometimes, people are asset rich, but cash poor because the things or investments they own have low liquidity. On the other hand, if you can quickly convert your assets into cash, it means those investments are highly liquid.

Liquidity in Life Insurance

Liquidity in life insurance refers to how easy it will be to obtain cash from your life insurance. You can take advantage of liquidity in life insurance policies in several ways.

1. Withdraw Cash Value

Typically, life insurance products that possess a cash value component, such as whole or universal life insurance, are more liquid. That is because you can simply withdraw from it to get a better cash flow. Your basis will determine how much money you can withdraw tax-free. Should you choose to also withdraw your insurance policy earnings, be prepared to pay taxes on that portion.

2. Use Dividends

Permanent life insurance policies, such as whole life insurance, tend to pay dividends regularly. But the amounts may depend on the performance of the investment. So if you have been reinvesting the dividends, you can choose to save them instead to improve your cash flow.

3. Surrender the Policy

Also, consider surrendering the policy in exchange for money. You can get the full cash value after deducting the surrender charge.

Unfortunately, this option will prevent your beneficiaries from enjoying the death benefits. And if the amount you have invested is not big enough, you may not have any cash value available after the surrender charges are paid. So, use this option if others are unavailable.

4. Sell Policy for Cash

Another option is to sell your policy for cash. The process is known as a life settlement and involves a third party, who will buy your policy by paying a lump sum amount that is higher than the cash value but lower than the death benefit. That person will continue paying the policy premiums and ends up collecting the death benefit in your place.

5. Borrow Against Your Policy

It is also worth noting that many kinds of life insurance enable you to build equity. So, when a financial emergency arises, you can tap into that equity and get cash instead. You could do so by using your equity as collateral when you borrow money up to the surrender value.

There is no point in having insurance and yet you cannot deal with financial emergencies. Therefore, ensure you include the option to convert some or all of your policy into cash when investing in insurance, especially life insurance. That way, you are not only covered against the insured events, but can also get cash for emergencies when you need it.