One of the most significant issues people have with life insurance policies is that they don’t understand what they’re paying for. Life insurance policies cover multiple services and benefits, and there are many different types to choose from, depending on your needs.
One of the key terms you’ll want to be familiar with when you select or renew your policy is liquidity, but what does it mean? Here’s everything you need to know about liquidity in life insurance policies.
In This Article
What does liquidity refer to in a life insurance policy?
Liquidity refers to how easily your policy can be turned into cash. While some policies offer a lump sum payout upon death, others have annuity or life settlement options that convert your deatWhat Does Liquidity Refer to in a Life Insurance Policyh benefit into a stream of payments for a set period—which could last months or even years.
Depending on your needs and preferences, either option can provide significant financial protection for you and your loved ones in an unexpected tragedy. For most consumers, term life insurance is considered the go-to option when it comes to purchasing life insurance coverage.
How Is Death Benefit Calculated Under an Ordinary Life Insurance Policy with No Face Amount Guarantee
To calculate your death benefit when there is no face amount guarantee on an ordinary life insurance policy, take your premium and divide it by 240. Then add 1% of that number (to represent administrative expenses) and multiply that sum by 365. The result is your death benefit. Suppose you die within one year of purchasing an ordinary life insurance policy with no face amount guarantee. In that case, it may be possible for you to receive up to 106% of your original premiums back as a death benefit.
Most companies only return 90% of what they collected from you during your first year; they keep 10%. If you purchased a $100,000 policy and died during your first year, your beneficiaries would only get $90,000.
However, if you lived past one year after purchasing such a policy, your beneficiaries would receive more than what they paid out. For example: If you bought an ordinary life insurance policy with no face amount guarantee for $1 million at age 40 and then died at age 41, your beneficiaries would receive $1 million minus 10%, or $900,000 plus interest minus taxes due on earnings from their bank account.
Premium Funding Options Under an Ordinary Life Insurance Policy
Ordinary life insurance policies cover only death benefits and don’t include cash value. The options available under such policies vary according to individual circumstances, but one common arrangement is known as premium funding.
In it, you deposit some money upfront and then pay monthly premiums for an agreed period—often two or three years. During that period, your policy will convert from a premium-funded policy into one with cash value.
Why Is Money Worth More Than Face Value on an Indexed Universal Life or Variable Universal Life (VUL) Product?
Indexed universal life and variable universal life policies have the built-in potential for tax-deferred growth, making them appealing products, primarily when used as part of a cash accumulation strategy.
When you own an indexed universal life or variable universal life policy, though, you’re two entities: You’re not only investing in your account but also contributing to an investment fund held by your insurance company.
How Much Money Can You Get When You Need It on a VUL Product With Surrender Periods, But No Face Amount Guarantee (High Cash Value)?
This is one of those times when more is less. A whole life policy with at least a 30-year guarantee and surrender periods but no face amount guarantee provide an element of guaranteed liquidity for consumers.
The reason that there are no guaranteed cash values on variable universal life products is that those premiums go towards building up your face amount and premium base, so you have lots of insurance protection and money saved up from policies that you can use as down payments or collateral for loans or other things.
An Example Showing How VULs Don’t Have the Same Benefit as Term Plans
The idea of what liquidity refers to in a life insurance policy is for an owner of any term life insurance policy or permanent product, and a death benefit will be paid. The insured person should select who will be delivered on their behalf after passing away. They will make sure that it includes their beneficiaries.
There are three different types of life insurance: basic, simple, and universal terms, Which provide certain advantages for each one.
Why is liquidity necessary in life policy?
A term life insurance policy is considered the default life insurance policy for most consumers, who are more familiar with its more famous counterpart, whole life. Term life provides temporary coverage during specific periods and is less expensive on an annual basis than its counterpart.
For most consumers looking at policies that protect their family’s financial futures in case of death, term life is ideal. It helps them mitigate risk and increase liquidity until they’re ready to purchase a long-term plan or need additional coverage.
It’s also important to note that those who have purchased vital person insurance policies usually don’t have enough assets or income to secure adequate coverage through traditional means—though it can also refer back again to liquidity issues within a business structure.
Who Is the Owner and the Beneficiary of a Key Person’s Life Insurance Policy?
While the owner and beneficiary on a key person’s life insurance policy may be the same person, there are times when they’re different. For example, if you’re a business owner, you might want your business to receive any money from your death benefit.
Critical person life insurance can help protect that business by covering the costs of training or replacing an employee or the value of an employee’s unique skill set.
The coverage is not just for companies, however. Professionals like doctors and lawyers often have a life insurance policy on them, so their family receives an inheritance from their death. Anyone with unique talents and experiences can be considered a key person and should have their insurance policy.
How Does Life Insurance for Estate Liquidity Work?
A life insurance policy that serves as an estate-liquidity vehicle must include death benefits and cash-value components. This ensures that money can be accessed before assets are sold, creditors are paid, and final expenses have been incurred. Term life insurance is considered the most straightforward way of achieving estate liquidity.
While you may have named your beneficiary on a key person’s life insurance policy, consider naming an additional beneficiary or an entity such as a trust if you don’t want future beneficiaries to fight for payments.
What is one thing you can do now?
See how all of your current life insurance policies work together, then look at purchasing another one for estate liquidity purposes.
When Must Insurable Interest Exist in a Life Insurance Policy?
For an individual to be eligible for a life insurance policy, they must have an insurable interest in that person’s life. An insurable interest can exist only between persons related by blood, marriage, affinity (adoption), contract, or business. In addition, there must be a current threat of financial loss related to that person’s death. The holder of a life insurance policy is referred to as its owner.
Is Life Insurance Considered an Asset for Mortgage?
Life insurance is an asset that can be used as collateral for mortgages. With critical person life insurance, an organization purchases life insurance on an employee who is considered essential for business operations.
This type of life insurance policy ensures that if something happens to that individual, their family will still receive financial support and coverage for additional expenses. So when you apply for a mortgage and want to use your life insurance policy as collateral, it’s essential to think about how much money would be left after you pass away.
Is Life Insurance an Asset in Divorce?
One of my clients wanted to know what happens if she has $100,000 of life insurance on her husband and he dies—is that money considered an asset for divorce purposes. The answer is both yes and no. If you own your spouse’s policy and your own, there’s no issue.
But if you only have access to his policy (or if he owns yours), it can be considered an asset – or at least a potential source of cash – in your divorce settlement. Since insurance policies are generally worth much less than they are at death, many states specifically exempt them from asset division during divorce proceedings.
Either way, make sure you talk with an attorney about how life insurance might impact your case before you do anything else.
Can All Life Insurance Policies Be Sold?
A life insurance policy insured for more than $500,000 typically cannot be sold. This is because it has significant value and so is not considered non-transferable.
The same rules generally apply if you want to sell your life insurance policy before it matures – unless it contains no cash surrender value and does not include accidental death or dismemberment coverage.
The most common types of life insurance policies are level term policies, which are set up with a particular premium payment every year until maturity, at which point, they stop paying out.