Life Insurance vs. Annuities

Life insurance and annuities are two types of long-term investments for financial planning that people often get mixed up with each other. While annuities are designed to provide money for you to live on, the goal of life insurance is designed to provide for others when you pass away.

There are several types and also advantages and disadvantages to both life insurance policies and annuities.

What is Life Insurance?

There are two types of life insurance: Term and Whole life insurance (or permanent).

• Term life insurance is only for a period of time – for example 20 years. It works best for people who want insurance until they reach retirement age, or to cover other types of time-specific situations.
• Whole life insurance provides money to your survivors after your death. With universal whole life, the premium goes toward a death benefit and in a savings or low-risk investment. With variable whole life, more of the premium goes toward riskier investments. Variable universal whole life insurance is a combination of universal and variable.

Advantages of Life Insurance

Considering a life insurance plan is an important part of your financial planning. Life insurance offers protection for your loved ones, preventing them from having to drastically alter their lifestyle should the unexpected happen.

• Life insurance provides peace of mind that your family members won’t struggle financially when you are gone. If you’re the breadwinner, this is particularly important. Depending on the policy’s amount, you won’t have to worry about the family’s home being foreclosed on. Additionally, your spouse won’t have to take on an additional job, and your kids won’t have to drop out of college to help pay bills.
• Funeral costs are also expensive – typically over $7,000. A life insurance policy ensures that your family won’t have the additional burden of wondering how to pay your funeral and burial expenses.
• Term life insurance is relatively inexpensive. For example, to get a 20-year term life insurance policy with $250,000 of coverage, your payments would start at approximately $15 a month. You can also renew the policy when the premium period is over. In addition, you can also convert your term life policy to a whole life policy.
• You can borrow the cash value of a whole life insurance policy (which is a tax-free loan) or you can surrender the policy for cash. Also, your insurance agent might not tell you this, but if your term life policy is eligible to be converted to a new policy, and the death benefit is at least $100,000, you can sell it to an outside investor and receive a cash payment.
• Money in your life insurance policy, whether the money is saved or invested, is tax-deferred until you withdraw it.

Disadvantages of Life Insurance

The disadvantages of life insurance occur when the decision to buy a policy isn’t considered carefully. For example, buying a life insurance policy when you don’t need one or buying a complex policy.

• There is a chance your policy can lapse. If this happens, the company won’t owe you or your family a dime. According to the Life Insurance Settlement Association (LISA), among consumers over the age of 65, over 250,000 life insurance policies lapse each year. The average value of those policies is $225,000. As a result, insurance companies gain over $57 billion a year due to lapses.
• Whole life insurance is much more expensive than term life insurance – it can be six or seven times more expensive. The payments are so expensive that many people can’t keep up with the payments.
• You’re less likely to benefit from term insurance because you might not pass away during the coverage period. After the term of a term life insurance policy has expired, you can renew it each year, but the premiums will begin to increase significantly.
• You cannot borrow any money from your term life plan. If you borrow from your whole life policy, you will have to pay the money back with interest (even though it’s your money).
• Life insurance also includes a variety of fees (administrative, management, and commissions) that you have to pay.
• Buying a life insurance policy when you don’t have a need for one puts you at a disadvantage. For example, if you’re 75 years old with no dependents or earning power, you don’t need a life insurance policy.

Life Insurance
	Term Life	Whole Life
Why Buy It?	Provide for dependents	Income for dependents or estate planning
Pays Out When	You die	You die, borrow the cash value, or surrender the policy
Form of Payment	Lump Sum	Lump Sum
Money is Tax-deferred?	No	Yes
Pays a Death Benefit?	Yes	Yes
Benefits Considered Taxable Income?	No	No, unless a withdrawal exceeds the premium sums
Annuities
	Deferred Annuities	Immediate Annuities
Why Buy It?	To grow tax-deferred money	To ensure a steady paycheck during retirement
Pays Out When	You make withdrawals	One period after you buy the annuity. Stops paying when you die.
Form of Payment	Lump Sum or income	Lifetime income
Money is Tax-deferred?	Yes	Yes, but only in the early years
Pays a Death Benefit?	Yes	Only if the annuity has a guaranteed-period option that doesn’t expire when you die.
Benefits Considered Taxable Income?	Yes, but only the sum derived from investment income	Yes, but only the sum derived from investment income

Source: Insurance Information Institute.

What are Annuities?

Annuities are another type of financial product sold by insurance companies. Money that you put into an annuity is then used to provide you with monthly (or annual) payments. However, this is not a bank, where you deposit money and have a balance that must be maintained. An annuity is designed to provide you with additional money, but it’s a gamble.

• Immediate Annuities are obtained by making a lump sum and you start receiving payments immediately. For example, if during your late 60’s, you took $110,000 and bought an immediate annuity, you could receive roughly $7,000 a year every year for the rest of your life.
• Deferred Annuities are paid out at a time in the future, for example, when you retire.

Annuities can also be fixed or variable. Fixed annuities have a fixed interest rate for a specified period of time. Variable annuities are placed in a variety of stocks, bonds and mutual funds and the rate of return is dependent on the performance of those investments.

Advantages of Annuities

Annuities are a great way to make sure you’ll have a steady income during retirement. They’re particularly useful for people who are closest to retirement age needing to catch up.

• There is no annual contribution limit with an annuity. If you’ve maxed out your contributions with other investment accounts like your 401(k) or Roth IRA, you can invest as much as you want in an annuity.
• Annuities are marketed as being safer (less risky) than mutual funds.
• With a fixed annuity, the company assumes investment risks. Regardless of market performance, you are usually guaranteed a minimum interest rate. On the other hand, with a variable annuity, your returns
  might be higher than with a fixed annuity.
• If you have a variable annuity, you get to decide where you want to invest your money in the stock market.
• You don’t have to pay taxes on investment gains for deferred annuities.
• Your annuity payment will last as long as you live. For example, if during your late 60’s, you took $110,000 and bought an immediate annuity, you would receive roughly $7,000 a year every year for the rest of your life. If you lived 20 years, you would have received $140,000, which is a very good value.
• If you get a variable deferred annuity, your beneficiaries will receive death benefits.

Disadvantages of Annuities

As with any investment, annuities carry certain disadvantages you should consider before deciding on investing in one.

• Income from an annuity is taxed just like regular income. This means there’s a chance that your tax
  rate might increase from the current time and the time you want your annuity to begin paying out.
• Once the insurance company meets the guaranteed amount, they can keep the rest of the money. Using the example listed above, let’s say you deposited $110,000 and received $7,000 a year. However, if you died after 10 years, you would have only received $70,000. That’s a significant loss. When you die, annuity payments cannot be passed on to your relatives. You could buy an additional rider, but that would be an extra cost.
• The certainty of your payments is based on the financial strength of the company you buy the annuity from. If it goes belly up, so will the money you’ve put into it. That’s why your funds need to be in a separate account that is not on the company’s balance sheets.
• High fees are associated with annuities. These include fees for managing your account, fees paid to an advisor, and fees for trading. They’re also known for hidden fees. If you withdraw money within a specified period of time (for example, within the first five years) you will have to pay a surrender charge, a fee of around 10 percent.
• While deferred annuities accumulate money tax-deferred, this only applies to immediate annuities in the beginning of the payout years.
• If you have a fixed annuity, you don’t get to choose how the money is invested. With a variable annuity, you have more choice, but you’re subject to market volatility.
• Young people cannot buy annuities. Consumers usually have to be at least 40 years old to purchase a deferred annuity, and 55 years old to purchase an immediate annuity.

Bottom Line

Life insurance and annuities are two products designed to provide financial support later in life and to provide assistance to survivors when your life is over. There are pros and cons to both products, and also a level of risk and assumption. However, by weighing each factor carefully, you can make the right decisions.

Learn More

• How Much Money Do I Need to Retire?
• What is a 401(k) Retirement Plan?
• What Is A 403(b)?