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Annuity vs life insurance

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Planning for the future is an essential part of life. Saving for retirement can take the pressure off of having to rely on others to care for you when you age. And providing for loved ones who depend on you with financial stability after you pass away may be the best gift you can give them. There are a couple of financial products that make financial planning for the future easier — life insurance and annuities.

Life insurance

There are a few types of insurances you’re likely to have in your lifetime: health, auto insurance, homeowners or renters coverage and life insurance. They’re all designed to financially cover you in the event of unexpected tragedy. 

Life insurance comes in various forms, each with a payout designed to help your loved ones deal with immediate financial concerns if you pass away.

Types of life insurance

Life insurance comes in various forms within two specific categories. 

Term life insurance

Term life insurance is the simplest and least expensive form of life insurance. Policyholders specify the amount desired for the death benefit, say $100,000 or $500,000, then choose a term of up to 30 years for the policy duration. If you pass away during the term, your beneficiaries receive the full death benefit, tax-free. Once the policy term is exceeded however, the policy is void, with no return on your premiums.

Whole life or permanent insurance

Whole life insurance, also called permanent insurance, pays out a death benefit but doesn’t have a term. Permanent insurance is typically more expensive because a portion of your premium goes to a cash value account that you can access during your lifetime. There are three main types of whole life insurance:

  • Whole life — traditional, interest-earning cash value account
  • Variable life — fixed premium payments and cash value funds, which can be invested
  • Variable universal life — flexible premium payments and cash value funds, which can be invested

What is an annuity?

Annuities help you plan for your future by setting yourself up with guaranteed payments for life. Because of the long-term payout, many people invest in an annuity to plan for retirement. Since an annuity will continue to pay you, even after your other retirement accounts are tapped out, they’re a good option for individuals who come from a family with a longer-than-average life expectancy.

Annuities are extremely flexible at the start and up till the end. You can pay into the annuity monthly or quarterly, or by paying a single lump sum up front. On the payout side, you could choose to receive your future annuity payouts as a single payment or as monthly, quarterly or as annual income. 

How does an annuity work?

An annuity is a long-term agreement or contract between yourself and an insurance company. You provide investment funds in the form of scheduled payments or a lump sum and receive guaranteed income in return at a later date. 

The annuity contract will spell out your payout rate. If the rate is 5% on a $150,000 annuity, you’ll receive $7,500 per year in payments for life. You could request your payout as one payment of $7,500 each year, or $1,875 per quarter or $625 per month, for example.

Who should buy annuities?

Annuities are a good option for individuals who are worried about outliving their retirement savings and in search of supplemental income in case their retirement funding runs out. People who didn’t save enough for retirement in their early years can catch up by contributing to an annuity.

Annuities are best for healthier people as well. They are designed to provide income long after other retirement funding runs out. If you have a health condition which may increase your risk of an earlier death, an annuity may not be worth the added expense.

Who should not buy an annuity?

Experienced investors would be better off steering clear of an annuity. You’re essentially trusting an insurance company to invest and grow it. If you’re a decent investor, you may be able to grow your money more effectively on your own using a tax-advantaged retirement account, such as an IRA.

In addition, individuals with a pension and sizable retirement savings may not need an annuity, since it’s likely their financial needs will be covered for the duration of their lives.

Types of annuities

Longevity annuity

A longevity annuity is considered the best-known type of annuity. It will provide you with income for as long as you live. There’s a caveat; longevity or advanced life delayed annuities require you to wait until you’re 80 to start receiving payments.

Immediate annuity

An immediate annuity is the most basic type. You provide a lump sum to buy in and choose how long you’d like to receive income for (several years to a lifetime). You can start receiving payments as early as a year after you open one.

Deferred annuity

Unlike an immediate annuity which provides income within one year, a deferred annuity pushes back the payout. Deferred annuities have two phases — the initial investment phase for your investment to grow and the income phase when you start receiving payouts.

Qualified vs. Non-Qualified Annuities

Annuities can provide varying tax advantages to better adapt to your financial situation. A qualified annuity is similar to an individual retirement account (IRA) or 401(k) — you purchase the qualified annuity with pre-tax dollars. The Internal Revenue Service (IRS) limits how much you can contribute per year. Withdrawals are taxed as income.

A non-qualified annuity is purchased with after-tax dollars and the premiums can’t be deducted from your annual gross income. There is no cap to how much you can contribute towards a non-qualified annuity. Withdrawals aren’t taxed, only the interest or earnings are taxable. 

Can you lose your money in an annuity?

Annuities are not insured by the Federal Deposit Insurance Corporation (FDIC) but they are considered fairly safe. For Florida and Texas residents, the annuities are protected from lawsuits and creditors.

Fixed index annuities are typically safer than variable ones. Insurance companies guarantee your payments if you have a fixed annuity. On each anniversary date, the company will put away the interest you’ve earned over a year so it can’t be lost. Variable annuities are more volatile and can rise and fall in value according to market conditions.

Life insurance vs annuity

Life insuranceAnnuities
Income for dependents after you dieIncome for yourself in the future until death
Usually one lump-sum payoutPayouts in installments
Benefits not taxableBenefits taxable if derived from investment income
Typically requires a medical exam to be issuedGuaranteed issue to all

The main difference between a life insurance policy and an annuity is who you’re planning for. Life insurance is designed to provide financially for your loved ones when you pass away. Annuities are designed to set yourself up for retirement until your death. Anyone can buy into an annuity — there is no medical examination or underwriting process required as there is with life insurance.

Where to buy a life insurance/annuity plan 

Life insurance can be purchased from insurance agents, directly through life insurance companies or through your workplace. Life insurance policies are more time consuming to set up and come with the risk of denial. You’ll need to go through an underwriting process which includes disclosure about your personal habits, such as how much alcohol you drink, smoking and other habits. In most cases, a medical examination and blood test will also be required.

Buying an annuity is an easier process. Annuities are a guaranteed issue, meaning anyone who can afford to pay for one is accepted. You can buy an annuity through an insurance company, investment broker or certain banks.

The takeaway

  • Annuities provide you with income until you die
  • Life insurance provides your loved ones with income after you die
  • Annuities are easier and faster to purchase because they’re a guaranteed issue

The key difference between life insurance vs. annuities is whether or not you are aiming to provide for yourself during life, or for your family in the event of your passing. Having both an annuity and a life insurance policy can be prudent, especially if you’re worried about outliving your retirement funds and your family depends on you financially.

Both annuities and life insurance policies come with a variety of options to provide you with payment flexibility and tax-advantages. Research your options and seek the direction of a financial advisor to determine which is best for your needs.

Cynthia Paez Bowman


Cynthia splits her time between Los Angeles, CA and San Sebastian, Spain. She travels to Africa and the Middle East regularly to consult with women’s NGOs about small business development.

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