How life insurance can help increase liquidity

Life insurance has always been helpful in providing financial protection for the family and loved ones after the breadwinner dies, but its unique characteristics can be used in many different ways. When access to capital is critical, no other financial instrument can provide the level of liquidity that life insurance provides for certain life and business situations.

Unique attributes of life insurance

In essence, life insurance is a simple arrangement in which the person with insurable interest pays premiums to the life insurance company in exchange for a promise to pay death compensation to the beneficiary of the insured. For permanent life insurance, the policy also provides a cash value portion, allowing the accumulation of premiums that have not been used to pay insurance costs. Life insurance is unique in that it provides tax incentives for policy owners and beneficiaries.

The policy owner (which may or may not be the insured) can accumulate cash value through tax-free income. Owners can obtain cash value for any purpose through withdrawals or loans on the insurance policy on a tax-free basis.In the case of withdrawals, the policyholder does not pay federal tax on the principal, which is generated in the policy before the proceeds. Loans are not taxed, but if they are not repaid, the death benefit will reduce the loan amount. Finally, the beneficiary does not have to pay taxes on death benefit proceeds. The combination of the characteristics of life insurance and tax advantages provides individuals and businesses with cost-effective liquidity.

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Survivors’ mobility needs

The most basic purpose of life insurance is to provide a direct source of funds for the surviving family members after the breadwinner dies. In many cases, a family’s assets may be related to the house, retirement plan, or business. If there is no other source of funding, the family may need to liquidate assets to pay final expenses, repay debts, or make up for lost income. Life insurance provides the instant liquidity needed by family members, thereby avoiding the sale of assets.

Real estate liquidity demand

For a family with a larger inheritance, the settlement cost of the estate may be sufficient to require the family to sell valuable assets, including real estate. This is especially problematic for families that need to continue their business. Tax-free income from life insurance can be used to offset settlement costs, which may include inheritance tax. Families usually rely on the liquidity provided by life insurance proceeds to preserve assets for future generations. Estate planners usually recommend placing life insurance in an irrevocable trust to prevent the proceeds from being included in the estate. Otherwise, the proceeds may increase the value of the estate, thereby increasing the estate tax.

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Business liquidity needs

When a key person or partner dies, the company will use life insurance as a source of funding. In many companies, the loss of key players will affect revenue, and the cost of finding replacements can be high. Life insurance provides the liquidity needed during the transition period. If the business partner dies, the family of the deceased will be entitled to a business. Life insurance is purchased as a financing mechanism under a sale and purchase agreement to provide liquidity for enterprises to purchase the benefits of the deceased partner from the family.

Corporate Life Insurance

The company purchases life insurance for the lives of its employees as a way to inject liquidity into the company. Companies that use company-owned life insurance (COLI) policies usually use company earnings to fund them, but companies may not always deduct premiums as business expenses. The cash value is accumulated tax-free, and the company can obtain it through withdrawals or loans for any purpose. COLI is commonly used to fund deferred compensation plans for executives. When an employee dies, the company collects a tax-free death pension, which can be used for any purpose.

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