Experts suggest that a liquid reserve of three to six months livings expenses is advisable, but my experience is that most people have less than that – much less. (Although I did read an anecdote wherein a friend of Joseph P. Kennedy’s said “Joe is the only person I know who can write a check for $10 million without selling something first.) Liquid assets are those that are available on a moment’s notice with no penalty.
The reason for liquidity is that it is impossible to plan for all of life’s contingencies. The roof springs a leak, the furnace goes on the fritz, the transmission starts slipping; the list is endless. Now hopefully they don’t all happen at the same time, but some degree of liquidity is necessary to keep them from being full blown catastrophes.
While a certain degree of liquidity can provide peace of mind, it comes with a price, and that price is liquid instruments tend to provide a minimal return. Liquid vehicles include money market accounts, savings account, checking accounts and cash on hand. Technically, a credit card that has cash advance feature offers liquidity, but if the cash advance isn’t paid in full by the next billing cycle, the “penalty” can be quite steep.
Cash value in a life insurance policy can also be viewed as a secondary form of liquidity. The funds are available within days, and while there is typically some cost associated with it, it is minor compared the cost of the credit card advance.
The need for liquidity doesn’t pass when we do. It is just as important, if not more so, to our beneficiaries. It’s not enough to just leave our heirs assets, it’s also important to leave them liquidity. Enter life insurance.
Unless the policy was less than two years old or there is no body, death claims are normally paid within 30 days, and oftentimes much sooner. This can be invaluable to an estate that has very little liquidity. Sure, assets could be sold, but death doesn’t always occur at an optimal time.
Suppose a person had an impressive investment portfolio but died in December of 2008. In case you forgot, the S&P 500 was down 37% that year. But if there was no liquidity, there would be no option but to liquidate a portion at sub-optimal prices.
A scenario where it may appear that there is no need for life insurance is that of a decent sized estate with considerable liquidity. But I submit to you that since liquidity has a very real cost in foregone potential earnings, the cost of life insurance could be, at least partially, offset by re-allocating a portion of the liquidity into more productive assets.
So yes, there are certainly scenarios where life insurance may not be necessary, but those scenarios are quite narrow in scope, i.e., the estate must be large enough for the beneficiaries to live on (but not so large that it triggers the estate tax), and there must be sufficient liquidity to address contingencies. Not too many people hit that sweet spot, which is why life insurance has a place in nearly all estates.