The main purpose of a life insurance policy is to provide your family with financial support when you pass away. However, some types of life insurance come with additional features that allow you to withdraw money from your policy while you’re alive.
Liquidity in life insurance refers to how easily you can get cash from your life insurance policy. Life insurance policies with a cash value component, such a whole life insurance, have liquidity because you can easily withdraw from them or surrender the policies for money.
A term life insurance policy doesn’t have liquidity because it doesn’t have cash value.
Most people only need the simple coverage a term policy provides. However, having liquidity in your life insurance can boost emergency or retirement funds for those with more complex financial needs.
Is life insurance a liquid asset?
Only some types of life insurance are considered liquid assets. A liquid asset is something that you own that can be easily liquidated — i.e., turned into cash — such as your investment account. For your beneficiaries, the death benefit is a liquid asset when it’s paid out to them.
Your life insurance policy is a liquid asset for you if:
Your policy has a cash value: Once your cash value has grown, you can make withdrawals from your policy much like a retirement account.
You can surrender your policy for cash: If you no longer need or can’t afford a permanent life insurance policy, you can surrender it and receive some of your cash value in return.
You are able to sell your life insurance: Elderly or seriously ill policyholders may be able to sell their life insurance policy if they no longer need it. This is also known as a viatical settlement.
In each scenario above, your life insurance policy is a liquid asset because you can easily extract cash from it.
However, life insurance is not usually the best way to build your assets—a policy sale or surrender earns you less than you’ve paid into the policy, while cash value investments have low interest rates. But these policies can be valuable if you’ve maxed out other investment options — or as ways to raise cash in an emergency.
A certified financial planner or independent insurance agent can help you decide if a policy with liquidity fits your needs.
Types of life insurance that offer liquidity
Liquidity in life insurance applies to permanent life insurance policies with a cash value, including whole, universal, and variable life insurance.
Permanent life insurance costs five to 15 times more than term life insurance, in part because a portion of your premiums go toward funding your cash value. Different types of permanent insurance grow your cash value in different ways and offer a greater potential return on your investment, and therefore more liquidity.
Whole life insurance: Grows at a rate set by your provider with a guaranteed minimum, like a savings account
Universal life insurance: Earns interest based on market index performance (e.g. the S&P 500) with a floor and a cap on gains set by your provider
Variable life insurance: You choose which funds to invest in; your gains and losses depend on market performance
Some policies, such as universal and variable universal insurance, let you use your accumulated cash value to pay your premiums. This frees up your cash on hand for other expenses and investments.
How liquidity can be written into a term life insurance contract
Term life insurance is not a liquid asset, but it does have an option to become a policy with liquidity. Most policies have a term conversion rider that lets you turn some or all of your term coverage into a permanent policy.
The option to convert your policy gives you the ability to extend your coverage, potentially at a lesser amount, if you still need it toward the end of your term.
A term conversion also creates a new account for tax-deferred savings, but remember that it takes decades to grow an investment. If you’re older, it may not be the best way to boost your assets.
If you don’t have convertible term life insurance, ask your provider about adding a conversion rider to your policy.
Is it worth getting a life insurance policy that offers liquidity?
Buying a cash value life insurance policy with liquidity is best for people who can afford the costly premiums and need additional tax-deferred investment accounts. For most people, the high cost of permanent insurance and low rate of return on the cash value make it a bad investment.
It’s better for your long-term finances to buy a term life insurance policy that expires in your retirement years and invest the money you saved by skipping a cash value policy. If you later find you do need some liquidity in your life insurance, you can explore term conversion options.