Key Takeaway
Annuities are generally designed to help cover you financially during your retirement and later-in-life expenses, whereas life insurance policies are typically designed to a benefit payment to your policy beneficiaries upon your passing. However, some life insurance policies can include features that can help provide a financial cushion during your lifetime, such as withdrawing from a cash value account on the policy.
How Are Life Insurance and Annuities Used Differently?
Annuities and life insurance are both designed to help provide financial protection. However, there are differences in the strategy of these two options. Annuities are typically used to grow your savings, providing income while you’re still alive. Life insurance, on the other hand, is typically used to pay your heirs when you pass away and help cover any end-of-life expenses. If you’re just diving into your life insurance and annuity options, they may seem like polar opposites. However, there are cases where annuities and life insurance can overlap and achieve similar goals.
While both life insurance and annuities can allow policyholders to invest on a tax-deferred basis and grow their savings, life insurance is typically heralded as the better option for leaving an inheritance. Annuities are more focused on investing and income guarantees.
What Is the Primary Purpose of an Annuity?
Annuities are long-term insurance products that can provide guaranteed income and are often used as a source for retirement income. This is because annuities typically provide a steady stream of cash payments at regular intervals. Additionally, the policy's earnings can grow tax-deferred until withdrawals are made. Annuities can also offer death benefits, which can help protect your original investment for any of your beneficiaries.
Death benefits on annuity contracts can give your beneficiaries a payout based on the terms of the contract and your final balance upon your passing. For example, if you bought an annuity for $100,000 and collected $75,000 in income payments, the death benefit for your beneficiaries may total to $25,000. However, some annuities do not pay a death benefit.
Fixed Versus Variable Annuities
There are many types of annuities, but fixed and variable annuities are the most common. A fixed annuity offers a fixed rate of return, and generally never falls below that minimum rate. This type of annuity can also give you the option to convert your account to a series of guaranteed income payments for a period of time or throughout the duration of your retirement.
Variable annuities, on the other hand, can offer growth potential based on underlying funds you’ve chosen. Annuities can also provide a guaranteed death benefit for beneficiaries and the option to annuitize, which is the process of converting your account into the guaranteed income payment structure listed above.
Who Should Choose an Annuity?
Annuities can be an option for individuals who would like to create an additional source of retirement income. Some individuals choose annuities when they are worried about running out of retirement income or if their Social Security benefits aren’t sufficient at covering their basic life expenses.
Of course, there are other reasons why you may want to choose an annuity beyond retirement. Some individuals opt for annuities when they want to ‘offload’ some financial risk to their insurance companies or are looking for ways to satisfy their required minimum distribution requirements.
What Is the Primary Purpose of Life Insurance?
Life insurance is primarily designed to provide a payout to your beneficiaries upon your passing. When you apply for a life insurance policy, you typically choose a specific death benefit dollar amount. During your lifetime, you pay monthly premiums to contribute towards this death benefit. If you pass away while covered by your insurance policy, your beneficiaries can receive this death benefit.
Some life insurance policies can include a cash value account, where a certain amount of your monthly premium is invested into this account that is tied to a market index. The cash value of this account can grow depending on the market’s performance, and this account may become a source of income during your lifetime, either through withdrawals or policy loans.
Term Versus Permanent Life Insurance
There are two main types of life insurance: term and permanent life insurance. Term life insurance typically only provides policyholders with a death benefit and no cash value account. This form of life insurance also has an expiration date, meaning your coverage may end before your passing even if you consistently pay your policy premiums in full and on time.
Permanent life insurance policies are typically designed to provide coverage until your passing. Certain policies can build cash value, but the return depends on the policy type and often, market performance. Some insurance policies pay a fixed interest rate, while others allow you to invest in subaccounts.
Who Should Choose Life Insurance?
People may choose life insurance over an annuity if their main goal is to make sure their loved ones receive a financial payment in the event of their passing. Life insurance is typically recommended for individuals with dependents who rely on the insured’s income, have mortgage, loans, or other significant financial obligations, or are looking for a tax-free way to help financially care for loved ones.
Life insurance can also provide tax-deferred ways to accumulate wealth through a cash value account in a policy. Policyholders with a term life insurance policy may also be able to build up their other assets while enjoying protection, because these policies can have lower monthly premiums compared to permanent life insurance policies.
