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What Does Liquidity Refer to in a Life Insurance Policy?

June 02, 2023
Our goal is to educate and advise on life insurance options, so you can feel confident in making the right choice, whether that’s through Quotacy or somewhere else. To ensure we provide accurate and trustworthy information, our writers follow strict editorial standards.

What does liquidity refer to in a life insurance policy? In this context, it means the ease with which you can convert your policy into cash. 

Life insurance can provide liquidity in two ways:

  1. During the insured’s life: Whole and universal policies have cash value accounts that the owner can access while alive.
  2. Immediately after the insured’s death: Every life insurance policy has a death benefit, which provides the insured’s loved ones with critical funds after they pass.

How Does Life Insurance Provide Liquidity?

Having a nuanced understanding of the relationships between life insurance, estate planning, and liquid funds is invaluable. First, you need to know why immediate access to cash is needed.

Upon your death, your loved ones may be saddled with unexpected bills, including:

  • Legal costs
  • Funeral costs
  • Tax obligations
  • Outstanding debts

While death doesn’t void taxes or debts, life insurance ensures these expenses are handled without depleting your loved ones’ financial resources.

Estate Liquidity: Your Cash Value

Depending on your policy and optional rider add-ons, there may be a few ways to access your life insurance funds while alive

However, permanent policies like whole and universal have built-in cash value accounts for personal use.

How does a cash value account work?

  • The policyowner is the only person who can access the money. 
  • They can make withdrawals or take out policy loans on a tax-free basis.
  • The funds are readily available, and insurers pay out quickly.

Estate Liquidity: Funds for Your Loved Ones

Without life insurance, they may resort to liquidating assets, like retirement accounts, to cover your end-of-life expenses and their cost of living.

Emptying such accounts may incur fiscal penalties, diminishing your loved ones’ financial safety net even further.

When you (the insured) pass away, the death benefit provides instant liquidity for your family.

How does the death benefit work?

  1. You designate one or more beneficiaries on your policy, and inform them of their status and its meaning.
  2. You eventually pass away and your beneficiary(ies) tell your insurer.
  3. They file a claim with the company.
  4. Typically, the payout follows promptly in the mail.
  5. Your loved ones short- and long-term economic concerns fall away.

Liquidity for Business Owners

Business owners have robust life insurance needsIf the owner or partner of a business dies, their share of the company passes down to their heirs. However, the next generation may not want to take over or may not be a good fit.

In that case, a stakeholder can establish a buy-sell agreement to ensure life insurance proceeds go to their estate in exchange for their share in the business.

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Why Do Estates Require Liquidity?

Estate taxes are due nine months after your death. Timely payment helps you avoid borrowing and paying interest.

If your estate is close to the federal tax exemption amount ($12.92 million for 2023), consider arranging your policy to avoid inclusion in the gross estate

Sufficient estate liquidity ensures assets left to your heirs and beneficiaries are distributed as intended rather than through probate.

Which Type of Life Insurance Is Right for Me?

The type of life insurance you need depends on your economic situation, personal needs, and financial goals.

Permanent life insurance — or a combination of term and permanent — is your best option if you have a large estate and want to leave an inheritance.

Term life insurance lasts for a predetermined number of years, usually 10-40. This option can meet your liquidity needs for death-related if you have a smaller estate.

Concerns about estate taxes and liquidity are valid, talk to a Quotacy advisor about permanent life insurance options. We provide unbiased advice; no high-pressure sales pitch.

Complete a short questionnaire to request personalized whole life insurance quotes, or compare term life insurance quotes in seconds without providing any contact information. 


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