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annuities vs life insurance

What Is the Difference Between Annuities and Life Insurance?

Categories: Annuity Education, Annuity Strategies, Investing, Retirement

Asking about the difference between life insurance and annuities is common.

The most common difference between life insurance and an annuity is that life insurance helps provide financial security to your loved ones if you pass away. Annuities provide either tax-deferred growth or a guaranteed stream of income in retirement.

Life insurance and annuities are excellent options to consider for your retirement strategy. In this article, we’ll detail why.

What Does Life Insurance Do?

Life insurance’s focal point is to guarantee financial security for loved ones after someone passes away. Life insurance can financially secure your loved ones’ future since death benefits can replace your income and meet critical financial necessities.

How Life Insurance Works

Life insurance provides financial protection by issuing beneficiary payouts when you pass away. Your loved ones can use this money the way they see fit so they can maintain their standard of living. Life insurance contracts typically require monthly, quarterly or annual premium payments and the amount you pay depends on various factors.

Life insurance can cover the following expenses:

  • Daily living costs
  • Funeral costs
  • College funds
  • Mortgage payments
  • And more

An important distinction to be made is that you don’t purchase life insurance for you; you purchase it for your loved ones.

What Do Annuities Do?

Annuities are insurance contracts that either provide tax-deferred growth or a guaranteed stream of income in retirement. Their primary purpose is to secure your retirement nest egg and provide financial security throughout. There are numerous types of annuities, including immediate and deferred, MYGAs, fixed, fixed-indexed, the list goes on.

The bottom line with annuities is that they provide numerous benefits, including:

  • Tax-deferred growth
  • Guaranteed principal with deferred fixed annuities
  • Future income streams that can’t be outlived
  • Probate avoidance
  • The possibility for lump sum benefits that can be paid to your spouse or children upon your death
  • And more

With income annuities, you can set up payments that last for your entire life, a specific period of time, or a combination of both.

How Do Annuities Work?

You can either buy an annuity with a lump sum of money or with premium payments made over time. The insurance company that provides the annuity then guarantees the terms of your annuity contract and invests your money accordingly, depending on the type of annuity you purchase.

You can buy annuities that begin payouts immediately, otherwise known as immediate annuities. Or you can buy annuities that delay payments until future dates, known as deferred annuities.

Life Insurance Details

Life insurance policies give you different options to choose from for your policy design and coverage duration. The policy type you choose depends on your needs. Some policies provide protection for a fixed number of years while permanent policies provide lifelong coverage and cash-value benefits. Permanent life insurance might also be the option to make withdrawals or borrow against your cash value.

You should also understand that life insurance policies have their drawbacks. The list of these drawbacks might include high mortality charges and fees. Also, a portion of policyholder premiums will typically go toward the insurance agent’s commission and this can hinder the savings growth portion of your life insurance policy.

Annual administrative and management fees can also mount, minimizing the benefits of the policy’s tax-sheltered growth. You might also struggle to clarify the fees structure; consequently comparing providers can prove difficult as a result. Unfortunately, a common occurrence is for policyholders to let their policies lapse due to their inability to continue making payments.

Because of their fees, some financial planners urge retirees to opt for lower-cost term insurance policies. They can then apply their savings toward other funds and financial products, such as a retirement plan or annuity. This structure lets policyholders make smaller life insurance payments and accomplish tax-deferred growth in their other accounts.

Some individuals might have already maxed out contributions toward their retirement plan accounts. In these cases, cash value policies might be an advisable option. This is especially true if they choose low-fee providers and have time to let their cash accrue.

High net-worth individuals might also place cash value policies into irrevocable life insurance trusts. Doing so can reduce their beneficiaries’ tax obligations.

Annuity Details

Whether fixed, fixed-indexed, or variable, the popularity of annuities has steadily increased over the years. Fixed annuities credit your account based on a guaranteed rate while variable annuities feature returns that depend on the stock or bond fund sub-accounts. Fixed-indexed annuities guarantee downside protection, with interest earnings determined by the performance of the selected  underlying indices, such as the S&P 500 Index.

Immediate annuities are best intended for those nearing or in retirement who need an immediate stream of income. Deferred annuities are best intended for those who can afford to let their money grow tax-deferred.

Most annuities are purchased with a lump sum, but some annuities will allow funding via periodic payments. You can also select the time you want your payouts to begin. You should also understand your payout and/or surrender options when you select an annuity. This determines when and how you will receive your income stream or cash out your annuity.

Annuities don’t come without potential fees, so you should speak with an annuity specialist who can walk you through their fee structure. For example, surrender fees issue penalties to annuitants for withdrawing funds too early or canceling the contract.

This means the money in annuities can be illiquid for a long period of time. Because of this, annuitants often sustain hits on distributions during the initial years of their contract.

Those considering annuities should also understand the tax treatment in detail. Earnings will grow on a tax-deferred basis when left to compound inside the contract. But if a policyholder withdraws funds before age 59 1/2, interest gains are subject to ordinary income tax and a 10% tax penalty imposed by the IRS.

All things considered, fixed annuities can be an excellent choice for anyone looking to secure their principal or for a guaranteed stream of income into their later years. Annuities are the only way to guarantee a stream of lifetime income that you cannot outlive.

Bottom Line – Annuities Vs. Life Insurance

Regarding life insurance and annuities, the most important thing to understand is that they both serve definitive purposes. You should consider them before you enter retirement to determine which best suits your needs. They might serve your needs in different ways at different times.

It’s also important to understand how you can implement them into your retirement strategy. At AnnuityAdvantage, we believe you should have a trusted annuity advisor who can guide you, in an informed way, to the annuity product that makes the most sense for your individual goals for the future.

Contact us today at 1 (800) 239-0356 to learn more about how we can help ensure you get the most out of your retirement strategy.