Life Insurance Annuities: Smart Diversification Strategy?

Life insurance annuities can be a good way to diversify your portfolio and protect your financial well-being. While life insurance policies protect your family's financial security in the event of your death, annuities provide a pension-like stream of income to fund your retirement. Annuities are insurance products that offer premium protection, ensuring the return on your initial investment. They are ideal for risk-averse investors as they transfer investment risk to the insurance company. Annuities can be customized to fit your unique financial needs and preferences, including riders for inflation protection. They are also tax-advantaged, allowing your earnings to grow tax-free until withdrawal. However, it's important to remember that annuities have lower growth rates than other investments, making them more suitable for shorter growth horizons. Consulting a financial advisor is recommended to determine if life insurance annuities align with your investment objectives, risk tolerance, and financial goals.

Life insurance vs annuities: what's the difference?

Life insurance and annuities are both insurance products, but they differ in how they pay policyholders. Life insurance is primarily used to pay your beneficiaries when you pass away, while an annuity grows your savings and pays you an income while you're still alive.

Life Insurance

Life insurance policies protect your family's financial well-being in the event of your death. The primary benefit of a life insurance policy is the death benefit paid to your loved ones as a lump sum when you pass away. This benefit is usually income-tax-free.

Life insurance policies are typically funded by monthly or annual premiums (payments) made over time. The younger and healthier you are, the lower your premiums will be. However, older people can still purchase life insurance policies.

There are two main types of life insurance: term life insurance and whole life insurance. Term life insurance provides a death benefit but is temporary and expires after a set number of years. Whole life insurance can last your entire life and also builds cash value, which you can withdraw or borrow against while you're alive.

Annuities

Annuities are financial products offered by life insurance companies. They are designed to turn your money into future income payments, providing a pension-like stream of income to fund your retirement. You can buy an annuity with either a lump sum payment or several payments over time. Annuities do not require health underwriting, so you are guaranteed to qualify as long as you have the money to buy the contract.

Annuities typically pay benefits monthly over time when annuitized. You can set up the annuity with a growth period to build your savings. The return depends on the type of annuity. For example, a fixed annuity pays a guaranteed interest rate, while a variable annuity lets you invest your savings in mutual funds.

Annuities can also include a death benefit. With this feature, the annuity would pay your beneficiary a payout based on the contract terms and your balance.

Whether you choose life insurance or an annuity depends on your needs and goals. Life insurance is a good choice if you want to ensure your loved ones are financially secure after your death. On the other hand, an annuity is a better option if you are worried about having enough income during retirement or want to create an additional income stream. In many cases, it makes sense to have both life insurance and an annuity to build a comprehensive "portfolio of protection".

Pros and cons of annuities

Annuities are a type of insurance contract designed to turn your money into future income payments. They can be a good way to diversify your portfolio and protect against market volatility, but it's important to weigh the pros and cons before investing.

Pros of Annuities:

• Guaranteed income stream: Annuities provide a guaranteed stream of income, either immediately or in the future, which can be particularly beneficial during retirement. This income is guaranteed for life, even if you live to be 120 years old!
• Diversified retirement income: Annuities can be a part of a diversification strategy, helping to guard against overall loss in portfolio value by providing a guaranteed income stream.
• Tax-deferred growth: Money invested in annuities that will pay out at a future date (called deferred annuities) grows tax-deferred, potentially resulting in lower taxes during retirement.
• Greater contribution limits: Annuities have higher contribution limits compared to qualified retirement accounts like 401(k)s and IRAs, allowing individuals to save more for retirement.
• Customizable: Annuity contracts can be adapted to match the buyer's needs, such as adding a death benefit provision for heirs or structuring the annuity for both guaranteed income and market growth.

Cons of Annuities:

• High fees and commissions: Annuities often have high fees and commissions compared to other investments like mutual funds. These fees can eat into the returns over time.
• Limited liquidity: Annuities typically have restrictions on when and how much money can be withdrawn, with surrender charges applied to early withdrawals. This limited liquidity can make it challenging to access funds in case of an emergency.
• Inflation risk: Annuities guarantee a predetermined level of payments, which may decrease in buying power if inflation spikes. While some annuities offer fixed increases to address inflation, it is still a risk to consider.
• Specific drawbacks: Different types of annuities are designed for different goals. What may be advantageous for one investor may not be suitable for another. It's important to pick the right annuity for your specific situation.

When to choose an annuity

Annuities are a type of insurance contract that provides a fixed and reliable stream of income for an individual, usually during their retirement. They are typically purchased later in life to provide additional income during retirement. The best time to buy an annuity depends on your individual circumstances, preferences, and financial goals. Here are some scenarios where choosing an annuity may be a suitable option:

• Worry of Outliving Retirement Income: If you are concerned about running out of income during your retirement, an annuity can provide a guaranteed income stream for life. This can give you peace of mind and ensure that you have a steady source of income, no matter how long you live.
• Creating an Additional Income Source: Annuities allow you to create an additional source of income during retirement. This can be beneficial if you want to maintain your standard of living or have additional financial obligations, such as medical expenses or other unforeseen costs.
• Longevity Insurance: If you expect to live a long life, an annuity can provide "longevity insurance." This means that you won't have to worry about outliving your retirement savings and will have a steady income stream for as long as you need it.
• Off-loading Financial Risk: By purchasing an annuity, you can transfer some financial risk to the insurance company. They guarantee a fixed income, so you don't have to worry about market volatility or the performance of your investments affecting your retirement income.
• Satisfying Required Minimum Distributions (RMDs): Annuities can be a simple way to satisfy your required minimum distributions from tax-advantaged retirement accounts. They provide a steady income stream that can help you meet these distribution requirements without having to manage multiple investments.
• Supplementing Social Security Benefits: If your Social Security benefits are not enough to cover your basic expenses during retirement, an annuity can help fill the gap. It can provide a steady income stream to ensure that your essential expenses are covered.
• Maximizing Payouts: Financial advisors typically recommend starting annuity payments between the ages of 70 and 75 to allow for maximum payouts. Waiting until later in life to annuitize your capital can result in higher monthly payments. However, this assumes that you have other sources of income to rely on until you start receiving annuity payments.

It's important to note that annuities may not be the best option for everyone. They often come with higher fees than other investment vehicles, and there may be more suitable alternatives depending on your financial situation. It's always advisable to consult a financial professional to determine if an annuity aligns with your financial goals and circumstances.

When to choose life insurance

Life insurance is a crucial tool to ensure your loved ones are financially secure when you pass away. Here are some scenarios where choosing life insurance is a prudent decision:

• You have dependents or financial dependents: If you have people who rely on your income, such as children or a spouse, life insurance can provide them with financial security in the event of your untimely death. It can help replace your income, ensuring they can maintain their standard of living and cover essential expenses.
• You have significant financial obligations: Life insurance can be beneficial if you have substantial financial commitments, such as a mortgage, business loans, or other debts. It can help pay off these obligations, reducing the financial burden on your loved ones.
• You want to leave money to your loved ones tax-free: Life insurance proceeds are typically tax-free for beneficiaries, making it an efficient way to pass on wealth to your heirs.
• You're looking for a budget-friendly protection: Term life insurance, which provides coverage for a fixed period, is an affordable option for those who need protection while building other assets or accumulating wealth.
• You have lifelong dependents or estate planning needs: Whole life insurance, a type of permanent life insurance, is suitable if you have lifelong dependents or require coverage for estate planning purposes. While it is more expensive than term life insurance, it offers lifelong protection and guaranteed benefits.
• You need flexibility: Universal life insurance offers flexible premiums and an adjustable death benefit. It is ideal for those who anticipate changing needs over time.
• You want to cover end-of-life expenses: Burial insurance, or final expense insurance, is designed to cover funeral, burial, and end-of-life medical expenses. It is a small whole life insurance policy that does not require a medical exam, making it accessible to seniors with pre-existing health conditions.
• You're concerned about chronic illness or long-term care: While standard life insurance doesn't cover these scenarios, you can purchase additional riders for living benefits that provide coverage for these situations.
• You want to supplement retirement savings: Life insurance can serve as a supplement to your retirement savings, especially if you're concerned about having enough income during retirement.
• You own a business or have co-signed debts: Life insurance can be essential if you own a business or have co-signed loans, as it can help protect your business partners or co-signers from financial burden in case of your untimely death.

It's important to note that life insurance needs vary for each individual, and it's always a good idea to consult a financial professional or advisor to determine the best course of action for your specific circumstances.

How to diversify your portfolio

Diversifying your portfolio is a way to manage risk by investing in a variety of asset classes and in different investments within asset classes. Here are some detailed and direct instructions on how to diversify your portfolio:

Diversify Across Asset Classes

Firstly, it's important to diversify across different asset classes. This means investing in a range of stocks, bonds, cash, and other investments. Diversifying across asset classes helps to minimize the effects of market volatility and smooth out the inevitable peaks and valleys of investing. It's important to note that diversifying does not guarantee future results, ensure a profit, or protect against loss.

Diversify Within Each Asset Class

In addition to diversifying across asset classes, it's crucial to diversify within each class. For example, when investing in stocks, consider investing in companies of different sizes and from different industries, sectors, and geographies. This helps to ensure that your portfolio is not overly exposed to specific sectors or industries that may be affected by the same market events. Similarly, when investing in bonds, consider varying maturities, credit qualities, and durations to reduce risk.

Use Index Funds and ETFs

Index funds and exchange-traded funds (ETFs) are great tools for building a diversified portfolio. These funds allow you to invest in a broad range of companies or industries at a low cost. They are also a more passive form of investing, which can be beneficial if you don't want to actively manage your portfolio. However, keep in mind that index funds may underperform in inefficient markets, and it's important to be aware of any hidden costs and trading commissions associated with these funds.

Consider Global Investments

Don't forget about the rest of the world when building your portfolio. Investing in international markets, such as emerging markets or Europe, can provide attractive opportunities and help protect your portfolio from negative events that may impact only the US or a specific region.

Periodic Rebalancing

Over time, the performance of your investments will cause the weightings in your portfolio to shift. To maintain your desired level of diversification, it's important to periodically rebalance your portfolio. This typically involves buying or selling certain investments to return them to their target weightings. Rebalancing should be done at least once a year, but ideally more frequently, such as quarterly or twice a year.

Know When to Get Out

While buying and holding is a sound strategy, it's important to stay informed about your investments and the overall market conditions. This will help you identify when it's time to cut your losses and sell a particular investment.

Frequently asked questions