Liquidity allows you to seize fleeting opportunities and face emergencies. But what does it mean in life insurance, and how should it affect your financial planning?



Liquidity in life insurance refers to how accessible the cash value of your insurance policy is without making losses. You can withdraw some of the cash value when needed or take a loan against the policy. The other option is to surrender the policy and receive a lump sum payment, but we suggest you avoid this option.



This post should help you understand the importance of liquidity in a life insurance policy and how it can benefit you in different situations. We’ll also cover the factors to weigh when choosing a life insurance policy with good liquidity.

What Is Liquidity in Life Insurance?

In general finance terms, liquidity describes the ease of redeeming an asset for cash without losing its value. For example, a financial transactions company is likely to be more liquid than a real estate company.

Assets like cash or other widely acceptable currencies are easier to redeem than selling a fleet of cars. You may have to sell the cars at a price lower than their market value to get the cash quickly.

In life insurance, your policy is an asset that has cash value. However, it’s also money you’ve locked away for future protection. What if you need the money for an emergency or to take advantage of a fleeting business opportunity?

Most people wishing to invest in life insurance ask this question. Your financial planning should include options for liquidity.

The Role of Cash Value in Permanent Life Insurance Policies

A permanent life insurance policy differs from a term life insurance policy as it offers lifelong protection and a cash value component.

The cash value in a permanent life insurance policy accumulates over time as you pay premiums. This value grows tax-deferred, and you can access it via withdrawals or loans while still living.

That said, the main purpose of permanent life insurance is to prepare your beneficiaries for success when you pass away. The cash value component is just a bonus that can provide additional financial security and flexibility during your lifetime.

How Cash Value in Life Insurance Works

The cash value in a permanent life insurance policy works like a savings account, but here are the differences: ‘Life Insurance vs. Savings Account.’

Some of your premium payments fund the death benefit coverage, while the rest goes into a cash value account. This money grows over time based on your insurer’s interest rate.

The longer you have the policy, the more cash value it accumulates. And unlike traditional savings accounts, the growth of your cash value is not subject to income tax until you withdraw it.

The more premiums you pay over the years, the more cash value you will accumulate. As this value grows, you can use it for various purposes, including:

  • Supplementing retirement income.
  • Paying for unexpected expenses.
  • Funding a child’s education.

How Liquidity Works in a Life Insurance Policy

The cash value feature offered by life insurance policies provides liquidity, meaning you can easily access it for monetary needs. The most common way to access cash value is through withdrawals or loans.

With a withdrawal, you can take out a portion of your policy’s cash value without affecting the death benefit. However, this reduces the amount of cash value available in the future.

In contrast, a loan allows you to borrow against your policy’s cash value while still maintaining the full death benefit. The interest rate on these loans is typically lower than traditional bank loans, and your beneficiaries won’t have to repay the loan if you pass away before paying it off.

It’s important to note, however, that any outstanding loans will be deducted from the policy’s death benefit when you pass. Always make timely loan payments to ensure your beneficiaries receive the full amount.

The Benefits of Liquidity in Life Insurance

The liquidity provided by your policy’s cash value can benefit you in many ways. Here are some examples:

  • In times of financial hardship, you can use the cash value to cover expenses without tapping into your other savings or investments.
  • If you have an emergency fund set up, you can keep it at a lower amount since you can access your life insurance cash value if needed.
  • Instead of taking out loans with high interest rates, you can borrow at lower rates using your policy’s cash value.
  • The accumulated cash value in your policy can supplement retirement income or help pay for unexpected medical expenses.
  • Tax-deductible contributions can be made to certain life insurance policies, providing a valuable tax-saving opportunity.
  • Your cash value can serve as collateral for other loans or help secure a mortgage.
  • Tax-deferred growth on your cash value can provide additional financial security in the long term.

How Viable Is Policy Surrender Liquidity?

While borrowing against your policy’s cash value is beneficial, we only suggest surrendering your policy for its cash value as a last option. It means terminating the policy and receiving the accumulated cash value in a lump sum.

When considering this option, it’s important to weigh the pros and cons:

Pros of Policy Surrender Liquidity

  • You gain immediate access to your savings and accumulated interests.
  • Enjoy the financial option to sort out difficulties or unexpected expenses.
  • It may offer a higher payout than surrendering early in the policy.

Cons of Policy Surrender Liquidity

  • You will lose all protection and benefits associated with the policy, including death benefit coverage.
  • The cash value received may be subject to taxation.
  • Surrendering the policy may result in surrender charges and fees, reducing the total amount received.
  • You will no longer have the option to borrow against your policy’s cash value in the future.

Example of Liquidity in a Life Insurance Contract

Suppose you have a whole life insurance policy with a current cash value of $230,000 after 13 years of paying premiums. The death benefit will be higher as the policy has accumulated cash value through dividends and interest.

If you surrender your policy for its cash value, you may receive the full $230,000 in one lump sum payment. However, this amount may be reduced by surrender charges imposed by the insurer. Depending on your individual tax situation, it could also be subject to taxation.

You’ll also lose all death benefit coverage and other benefits associated with the policy. Additionally, surrendering your policy may impact your long-term financial goals.

If you were planning on using the death benefit as part of your retirement income or leaving it as an inheritance for your family, surrendering the policy would eliminate those possibilities.

If you keep the policy and continue making premium payments, your cash value will grow over time. In addition, you can still borrow against this cash value if needed.

Borrowing helps you avoid the tax implications of surrendering a policy. However, it may add interest and fees to the original amount borrowed and reduce the death benefit paid to your beneficiaries.

Still, loans based on life insurance policies often impose lower interest rates than traditional loans, so they’re more viable when you need quick cash.

Comparing Liquidity Across Different Types of Life Insurance

Different life insurance policies offer varying levels of flexibility.

Whole life insurance policies, for example, typically have a higher cash value and more options for borrowing compared to term life insurance policies. These policies build cash value over time while offering a death benefit.

Term life insurance policies don’t accumulate cash value and are primarily intended to provide a death benefit during a specific period. As such, they often have lower premiums, but their liquidity options are limited.

Learn more on ‘Whole Life Insurance vs. Term Life Insurance.’

Then there’s universal life and variable universal life policies, arguably hybrids of whole and term life insurance. They have the potential to build cash value while also providing a death benefit, but may require ongoing payments for the policy to remain active.

We Customize Your Life Insurance for Optimal Liquidity

We’ve agreed that liquidity should be a major consideration in your financial planning. Different types of life insurance policies have unique liquidity benefits and drawbacks.

At Professional Insurance Plans, we offer customized solutions for your specific needs. We’ll work with you to find a life insurance policy that balances liquidity and death benefits for your goals and situation.

Let our experts review your current financial plan and advise on how life insurance can fit into it. We’ll also explain in detail how each policy works, including any potential risks or limitations to consider.

Posted in Life Insurance