Supplementary Annuity And Life Insurance: Understanding The Basics

Life insurance annuities are a method of paying out a life insurance death benefit in a series of regular, fixed payments instead of a lump sum. This option is ideal for beneficiaries who prefer smaller, more manageable payments over a large sum. There are two types of life insurance annuities: fixed-period annuities and lifetime annuities. Fixed-period annuities pay out the death benefit over a specified period, such as 10 or 20 years, while lifetime annuities provide payments over the beneficiary's lifetime. Life insurance annuities are different from life annuities, which are retirement investment products providing fixed payments to the policyholder during their retirement years.

Life insurance annuities vs life annuities

Life insurance annuities and life annuities are distinct financial products with different purposes, beneficiaries, and payout structures.

Life Insurance Annuity

A life insurance annuity is a method of paying out a life insurance death benefit. Instead of a lump sum, the beneficiaries receive a series of regular, fixed payments. This option is ideal for beneficiaries who prefer a steady income stream and find it easier to manage smaller, periodic payments than a large sum.

There are two types of life insurance annuities: fixed-period annuities and lifetime annuities. Fixed-period annuities pay out the death benefit over a specified period, such as 10 or 20 years, while lifetime annuities pay out the benefit over the beneficiary's lifetime, with the monthly payout amount based on their age.

Life Annuity

On the other hand, a life annuity is a retirement investment product. It provides fixed payments at regular intervals, offering a guaranteed income stream during retirement. Individuals buy an annuity with a lump sum payment or multiple payments over time. A growth period can be set up, allowing savings to accumulate over time.

Key Differences

The primary purpose of a life insurance annuity is to provide financial protection for loved ones after the policyholder's death. In contrast, a life annuity focuses on protecting the policyholder's financial well-being by providing a pension-like income stream during retirement.

Life insurance annuities pay out to the policyholder's beneficiaries, such as a spouse, children, or designated heirs. On the other hand, the policyholder (and sometimes their spouse) is the primary beneficiary of a life annuity.

Life insurance annuities offer a steady income stream to beneficiaries following the policyholder's death. Conversely, life annuities provide guaranteed income to the policyholder during their lifetime, ensuring they do not outlive their assets.

Life insurance annuities are often chosen when the death benefit protection is crucial for loved ones, such as when there are dependents or significant financial obligations. Life annuities, on the other hand, are typically purchased later in life to supplement retirement income and address concerns about longevity.

While life insurance policies are usually funded by monthly or annual premiums, life annuities are generally funded by one or more lump-sum payments.

Fixed-period vs lifetime annuities

Fixed-period annuities and lifetime annuities are two types of life insurance annuities, which are methods of paying out a life insurance death benefit in a series of regular, fixed payments instead of a lump sum.

Fixed-Period Annuities

Fixed-period annuities pay out the death benefit in regular payments over a specified period, such as 10 or 20 years. The insurer divides the death benefit amount by the payout period to determine the payout amounts. By the end of the fixed period, the death benefit will have been paid out in full. Beneficiaries can choose other loved ones to receive payments if they pass away before the payout is complete.

Lifetime Annuities

Lifetime annuities pay out the death benefit over the beneficiary's lifetime. The insurer calculates the monthly payout amount based on the beneficiary's age. Lifetime annuity payments may be smaller if the beneficiary's life expectancy is long. However, the beneficiary can enjoy regular payments for life.

Fixed-Period vs. Lifetime Annuities

The main difference between fixed-period and lifetime annuities is the length of the payout period. Fixed-period annuities offer a specified number of years of payments, while lifetime annuities provide payments for the rest of the beneficiary's life. Another difference is that with fixed-period annuities, the payments depend on the amount paid into the annuity, the length of the payout period, and the interest rate. In contrast, lifetime annuity payments are based on the beneficiary's age, the amount paid into the annuity, and the interest rate.

Both fixed-period and lifetime annuities have their advantages and disadvantages. Fixed-period annuities guarantee a fixed number of payments, which can provide peace of mind and help with financial planning. However, if the beneficiary passes away before the end of the fixed period, the remaining payments may be forfeited. On the other hand, lifetime annuities ensure that the beneficiary receives payments for their entire life, but the payments may be smaller if the beneficiary has a long life expectancy.

Supplemental life insurance and what it covers

Supplemental life insurance is an optional coverage that provides an extra layer of protection on top of the group policy your employer provides. It is designed to provide additional coverage and is typically associated with a much lower payout than traditional life insurance policies.

Supplemental life insurance can be offered by an employer, union, or other membership-based organization. It is often offered as part of an employee benefits package, with the opportunity to purchase this additional coverage. It can also be purchased from a private insurer to supplement an employer's basic plan.

There are typically two components to life insurance offered through an employer or organization: basic group insurance and supplemental life insurance. Basic group insurance is often offered for free or a minimal premium and provides a death benefit that is typically capped at low amounts, such as one year's salary.

Supplemental life insurance allows you to add to the death benefit by paying an additional premium out of pocket. The amount of supplemental coverage is usually in multiples of your salary. For example, you could choose to pay for up to five times your salary in supplemental life insurance.

Supplemental life insurance typically falls into one of three categories: term, permanent, and spouse/child coverage. Term life insurance is temporary and lasts for a stated period, such as 10 or 20 years. It is less expensive to buy when you are younger, but the premiums typically rise over time. Permanent life insurance, on the other hand, does not expire and continues as long as you keep paying premiums. Spouse/child coverage allows you to buy coverage at a lower group rate for your spouse and/or children.

Supplemental life insurance can provide extra support for your loved ones in the event of your unexpected death. It can help cover burial costs, pay off mortgages, or fund a child's college education. It is important to note that supplemental life insurance is not always portable, so you may lose your coverage if you leave your job.

Supplemental life insurance is a good option if your existing coverage does not meet your specific needs or provide enough support for your family in the event of your passing. It can also be beneficial if you need a plan that will still cover you if you change jobs.

How annuities are paid out

Annuities are a financial product designed to provide a regular, guaranteed income stream over a specified period or for the rest of a person's life. They are typically used as part of a retirement strategy to ensure a steady flow of income during one's post-employment years. Annuities can be purchased with a single lump sum of money or through flexible premium payments over time. In return, the annuitant receives income during their retirement period in the form of regular, fixed payments or a lump sum.

There are several types of annuities to choose from, each with its own unique features and benefits. Here are some common annuity payout options:

• Life-only annuity: This option provides regular, guaranteed income payments from your annuity for life. The payment amount is determined by factors such as your contract value, age, gender, interest rate, and life expectancy. By choosing this option, you eliminate the risk of the income source running out before your death.
• Joint and survivor life annuity: This option ensures that the retirement income provided by your annuity will continue for your spouse after your death. However, the payments are calculated based on the life expectancy of both you and your spouse, resulting in lower payments compared to the life-only option.
• Fixed period annuity: This option allows you to select a specific time period for your annuity payments. Since you won't be receiving payments for life, the payments are typically higher. If you die before the specified period ends, the remaining payments will be made to your designated beneficiary for the rest of the fixed period.
• Life with period certain annuity: This option provides you with guaranteed income for life while also allowing you to select a specific time period for your annuity to pay your beneficiary if you die before the guaranteed period ends. While this option offers income for life, the payments are generally smaller than the life-only payout.
• Fixed amount annuity: This option lets you choose the amount of monthly payment you want to receive. The payments continue until the total accumulated value has been paid out. The duration of payments depends on both the chosen amount and the annuity's accumulated value at the time of annuitization. The insurance company cannot guarantee that you won't outlive your income payments. If you die before the full amount has been paid out, the remaining balance is typically paid to your designated beneficiary.
• Lump-sum payment annuity: This option allows you to receive your annuity payout in one lump sum. However, you will have to pay income taxes on the entire investment-gain portion of your annuity in the year you take the lump sum. It is essential to consult a qualified tax professional or financial advisor before opting for a lump-sum payment.

When selecting an annuity payout option, it is important to consider factors such as the desired income amount, the expected duration of payments, and the needs of any beneficiaries. Additionally, it is crucial to understand the tax implications associated with each option.

Annuities and their tax implications

Annuities are tax-deferred retirement investments. The tax implications of an annuity depend on how it is funded and whether it is a qualified or non-qualified annuity.

Qualified Annuities

Qualified annuities are generally funded with pre-tax dollars, though Roth annuities are funded with after-tax money. They are subject to required minimum distribution (RMD) guidelines unless it is a Roth IRA (Roth 401(k)s will not be subject to RMDs in 2024). You must begin taking distributions from a qualified annuity by April 1st of the year after you reach your RMD age, which is currently 73 and will increase to 75 in 2033. The entire distribution amount is subject to income taxes.

Non-Qualified Annuities

Non-qualified annuities are funded with after-tax dollars and grow tax-deferred. They are exempt from RMD guidelines during the owner's life. Once you start taking distributions from a non-qualified annuity, any interest or earnings within the annuity will be distributed before the premium or principal amount. The distributions of interest or earnings are taxed as ordinary income, but you won't pay taxes on distributions of the premium or principal you initially deposited.

Withdrawing from an Annuity

Withdrawing from an annuity before the designated time period can result in early withdrawal penalties. Withdrawals made before the age of 59½ are typically subject to a 10% early withdrawal penalty tax. For early withdrawals from a pre-tax qualified annuity, the entire distribution amount may be subject to the penalty. If you withdraw money early from a non-qualified annuity, typically only the earnings and interest will be subject to the penalty.

Inherited Annuities

Inherited annuities do not have a step-up in tax basis. This means that the original owner's tax basis on non-qualified annuities will remain the same, and the beneficiary will have to pay taxes on all earnings. Qualified annuities are fully taxable as income in the year the money is received by the beneficiary.

Frequently asked questions