Annuities Vs Life Insurance: What's The Real Difference?

Life insurance and annuities are both financial products offered by insurance companies, but they serve different purposes. Life insurance is designed to benefit your family or loved ones in the event of your death, whereas annuities provide an income stream during retirement to protect your financial well-being. Life insurance policies typically require health and financial underwriting, while annuities offer guaranteed qualifications regardless of health status. Life insurance policies are funded by monthly or annual premiums, while annuities are usually funded by lump-sum payments. The primary benefit of life insurance is the death benefit paid to beneficiaries, whereas annuities provide a pension-like stream of income during retirement.

Life insurance beneficiaries vs. annuity beneficiaries

Life insurance and annuities are two different financial products that serve distinct purposes. While life insurance policies protect your family's financial well-being in the event of your death, annuities provide a pension-like stream of income to protect your financial well-being during retirement.

Life Insurance Beneficiaries:

Life insurance beneficiaries are the individuals or entities designated by the policyholder to receive the death benefit upon their passing. These can include a spouse, children, or other family members, or even charities. It is important to carefully choose beneficiaries and keep the designations up to date, as this ensures that the benefits are distributed according to the policyholder's wishes. Failure to name a beneficiary may result in delays or complications in benefit payments.

Annuity Beneficiaries:

With annuities, the primary beneficiary is typically the annuitant themselves, receiving income payments during their lifetime. However, some annuities offer a death benefit, allowing the owner to designate a beneficiary, often a spouse or family member, to receive the remaining payouts or a guaranteed minimum after the annuitant's death. This death benefit ensures that the invested funds provide financial support to the annuitant's heirs.

Key Differences:

The main difference between life insurance and annuity beneficiaries lies in the timing of payouts. Life insurance beneficiaries receive a lump sum death benefit after the policyholder's passing, while annuity beneficiaries, including the annuitant themselves, receive periodic payments during the annuitant's lifetime. Life insurance beneficiaries are typically spouses, children, or dependents, while annuity beneficiaries can be the annuitant, their spouse, or other designated heirs.

Payout structure

The payout structure of an annuity differs from that of life insurance in several ways. Annuities are typically paid out in monthly instalments over time, providing a steady stream of income during the annuitant's lifetime. This can be a fixed monthly income or an income that fluctuates based on investment performance. On the other hand, life insurance pays out a lump sum to the beneficiaries upon the policyholder's death. This lump sum is usually tax-free and can be used to cover missed income, funeral costs, and outstanding debts.

Annuities can be structured in different ways, such as deferred annuities, which have an accumulation phase where funds grow tax-deferred until the annuitant starts receiving payments, and immediate annuities, which begin making payments shortly after the initial investment. Single premium immediate annuities (SPIAs) provide income for either a predetermined period or the annuitant's lifetime. If the annuitant passes away before the predetermined period ends, the remaining payments go to a named beneficiary.

The payout structure of annuities can also vary depending on the type chosen. Fixed annuities offer stable and secure returns, as the interest rate is predetermined and remains constant for a set period. Variable annuities, on the other hand, offer several investment options, such as mutual funds, stocks, or bonds, and their returns fluctuate based on market performance. While variable annuities offer higher growth potential, they also come with greater investment risk.

Life insurance policies also have different types, including term life insurance, which covers a specified period, and permanent life insurance, which offers lifelong coverage and accumulates cash value over time. Term life insurance typically has more competitive premiums, while permanent life insurance may have higher premiums but provides additional benefits, such as the ability to borrow or withdraw from the accumulated cash value.

Annuities and life insurance policies can both include death benefits, but the size of these benefits differs significantly. Life insurance policies offer a larger death benefit, which can be a substantial five-figure sum or more. In contrast, annuity death benefits are much smaller and are typically subject to income tax.

Taxation

Annuities and life insurance policies both allow individuals to invest on a tax-deferred basis. However, there are some key differences in how these two financial products are taxed.

Annuities are tax-deferred retirement investments. Whether an annuity is funded with pre-tax or post-tax money will affect how it is taxed. Annuities funded with pre-tax money will be taxed as income when payments are received. Annuities funded with post-tax money will only have the earnings taxed.

Qualified annuities are generally funded with pre-tax dollars and are subject to required minimum distribution (RMD) guidelines. Non-qualified annuities are funded with after-tax dollars and are exempt from RMD guidelines during the owner's life.

For life insurance, the taxation depends on the type of policy. Term life insurance provides a death benefit but does not build cash value, so there are no tax implications. Permanent life insurance policies can build cash value, which can be withdrawn or borrowed against. Withdrawals of up to the amount of premiums paid can be made tax-free, but withdrawals of gains will be taxed as income. Policy loans are not taxed as income, but the insurer will charge interest on the outstanding loan.

Annuity death benefits are taxable, whereas life insurance death benefits are received income-tax-free by heirs.

In summary, the taxation of annuities and life insurance policies can be complex and depend on a number of factors, including the type of product, the funding source, and the timing and amount of withdrawals. It is important to consult with a tax professional to understand the tax implications of these financial products.

Funding

Life insurance policies are usually funded by monthly or annual premiums (payments) that you make over time, whereas annuities are typically funded by one or more lump-sum payments.

People invest in or purchase annuities by making monthly premium payments or lump-sum payments. The holding institution then issues a stream of payments for a specified period of time or for the remainder of the annuitant's life.

The accumulation phase is the first stage of an annuity during which investors fund the product with a lump-sum payment or periodic payments. The annuitant begins receiving payments after the annuitization period for a fixed period or the rest of their life.

With life insurance, you pay a monthly premium (the amount you pay varies depending on several factors, including the type of life insurance you own).

Underwriting

On the other hand, annuities offer guaranteed qualification, meaning that anyone can buy an annuity regardless of their health status. Nevertheless, financial underwriting questions, as well as minimum and maximum age requirements, may still apply. Additionally, certain types of annuities, such as a single premium immediate annuity (SPIA), may require some medical underwriting if they are rated products. In these cases, the insurance company assigns a rating to the annuitant based on their health status and other risk factors, which can affect the payout amount.

Frequently asked questions