Annuity vs. Life Insurance: What’s the Difference is a question that most people tend to get curious about. You might think about applying for a life insurance policy or purchasing an annuity when you’re making financial plans for the future. Insurance companies offer both products, which are useful for financial planning.
An annuity pays out income from the time you retire until your death, whereas life insurance is intended to benefit your family after your death. Annuities and life insurance have specific functions, advantages, and disadvantages. However, what you should ask yourself is which is more suitable for you. Or should I consider buying both? This article will explain annuity vs. life Insurance: what’s the difference?
What is Annuity
Annuities are insurance agreements that enable investors to convert their funds into future income payments. They can be purchased in one lump sum payment or in several installments over time. Annuity types, such as fixed and variable annuities, influence returns. Annuities protect against living too long and running out of money.
They can be set up for a specific time period or to last forever. Additionally, annuities can also provide a death benefit, which is paid out to heirs based on the contract’s terms and remaining balance.
How Does Annuity Work
A contract governing an annuity is made between you and the life insurance provider. You can choose to receive income from the insurance company for the duration of your lifetime, or for as long as you live. The insurance company will pay the premiums. An annuity can be thought of as the antithesis of life insurance in terms of protection. Annuities guarantee your lifetime income so you won’t outlive your assets or money, whereas life insurance protects your loved ones in the event of your death.
Advantages of Annuity
One of the major advantages of an annuity is to generate income that you cannot outlive which guarantees lifetime income. Annuities, also known as longevity insurance, are financial instruments that prevent individuals from outliving their savings. Furthermore, other advantages may include;
- Growth in investments deferred: Annuities provide growth in investments deferred, much like a 401(k) or traditional Individual Retirement Account.
- No restrictions on contributions or income: Annuities offer a flexible retirement plan with no income restrictions and the freedom to make unlimited annual contributions. This makes them a suitable option for those who have exhausted other retirement plans.
- Absence of health testing: Not having health issues is irrelevant when applying for an annuity.
Disadvantages of Annuity
Annuity doesn’t just have but also disadvantages. Annuities have a disadvantage in early withdrawal due to their long-term nature, which may result in surrender charges from insurers and a 10% early withdrawal penalty from the IRS for those under 59½. Other disadvantages include;
- Initial income payments are non-refundable: You cannot withdraw your money once you start receiving annuity income. You can’t access your savings as much as before.
- Annuity income taxes: After receiving your annuity gains, you owe income tax. It’s not retirement money exempt from taxes.
- Ongoing contract fees: To pay for investments, death benefits, income guarantees, and administrative expenses, annuities may impose an annual fee of up to 3%. Compared to investing in a retirement account or brokerage, you owe more fees.
What is Life Insurance
A life insurance policy can offer your spouse, kids, or other loved ones financial coverage. You will pay an amount known as a premium to the insurer either monthly or annually as a policyholder. The insurer then gives your beneficiaries a death benefit, which is a fixed sum of money, upon your passing.
The life insurance payout can be used by your loved ones to settle debts, help with burial expenses, and make up for lost income. Furthermore, you may choose from a wide variety of life insurance policy types, such as term, whole, variable, and final expense life insurance.
How Does Life Insurance Work
The people you care about the most can benefit greatly from the financial security that life insurance offers. When you pass away, a life insurance policy pays your beneficiaries in cash. However, your loved ones are free to use the funds they see fit to meet their needs. This may include keeping up their current level of living, covering their mortgage, or paying for schooling. Generally, you pay a monthly premium (the exact amount depends on some factors, including the type of life insurance you own).
Advantages of Life Insurance
- Flexible access to cash value: The cash value of your life insurance is yours to borrow or take out whenever you’d like. The IRS does not impose an early withdrawal penalty.
- Loans with cash values are tax-free: You can withdraw your gains without having to pay income tax if you borrow your cash value. You can obtain tax-free retirement income by using this method.
- Convertible into an annuity: The cash value of your life insurance policy may be exchanged for an Annuity. Taxes are not due for the change you made. Annuities, however, cannot be exchanged for life insurance.
- Generate a sizable death benefit that is free from income tax: In addition to increasing your cash value, life insurance can help you leave a sizable inheritance.
Disadvantages of Life Insurance
- Requires health underwriting: To purchase a policy, you must meet the health requirements set forth by the life insurance company. Pre-existing medical conditions may result in premium increases or possibly policy denials.
- Continuous insurance expenses: To maintain your life insurance policy, you must continue to pay the premiums. This is a continuous expense that reduces your yield.
- Builds cash value slowly: It may take a few years to begin realizing cash value and up to ten years to break even on your premiums. Before the cash value, the majority of your payments are applied to the insurance.
- Reducing the death benefit by using cash value: Reducing cash value means less money left over for your beneficiaries.
Annuity vs. Life Insurance: What’s the Difference
Even though insurance companies offer both life insurance and annuities, their benefits are very different:
- Annuities and life insurance have different objectives. While life insurance covers your heirs in the event of your death, an annuity may protect your income for the rest of your life.
- Life insurance pays out cash to the policyholder’s heirs upon death, whereas annuities provide the contract holder with a stream of income while they are still alive
- While life insurance is paid in regular installments over time, usually on a monthly or quarterly basis, annuities can be purchased in one lump sum or over time.
- Retirement planning calls for the use of annuities, but purchasing life insurance is a wiser move to avoid financial disaster.
- While annuities do provide a death benefit, much like insurance, their main function is to provide a steady flow of income.
- Medical exams may be necessary for life insurance, but they are not necessary for annuities.
These are some of the most significant differences between life insurance and annuities.