Most life insurance companies sell both life insurance policies and annuities. Both require you to be in good health to get the best rates. And both provide financial security. But they play very different roles in your financial portfolio.
How They Work
When you buy life insurance, you name a beneficiary (usually a person, but sometimes a charitable organization). When you die, your beneficiary receives the policy’s benefit, or claim payment. When you buy an annuity, you generally receive the annuity’s benefit yourself, while you live.
Most people buy life insurance to protect a spouse, child or other family member from the loss of income after they die. On the other hand, people buy an annuity to meet their own retirement and other long-range goals.
When you buy insurance, you pay premiums to keep the policy in force, or active. When you buy an annuity, you make a series of payments or a lump-sum payment. In return, the insurer agrees to make periodic payments to you beginning immediately or at some future date. These periodic payments may last for a definite period, such as 20 years, or an indefinite period, such as your lifetime or the lifetime of you and your spouse.
• You can buy both life insurance policies and annuities from a life insurance company. Although you can buy lump-sum policies or annuities, most often you make periodic payments to the insurer for your policy or contract.
• Both require underwriting, where a specially trained underwriter, aided by software, will calculate your mortality risk, decide whether to offer you a policy or an annuity contract, determine the appropriate premium, and write a policy or annuity contract to cover you.
• State insurance departments regulate insurers and agents/brokers who sell both “traditional” life insurance policies and fixed annuities. Variable annuities and variable life insurance policies have an investment component and therefore are securities regulated by the SEC.
• Fixed annuities have guaranteed rates and therefore no investment risk. Most states allow someone with a life insurance license to sell fixed annuities. However, some states, such as California, require a life insurance agent to obtain additional training before selling any annuities. Variable annuities have an investment component, and therefore pose an investment risk. Anyone who sells variable annuities must have a FINRA Series 6 or 7 securities sales license.
• Both life insurance and annuities are designed to meet long-range goals.
• Both life insurance and annuities come in three basic forms. For whole life policies, you can choose from ordinary whole life, universal life and variable life. (Some insurers offer variable universal life policies, which combine features of universal and variable policies.)
There are generally three types of annuities—fixed, indexed, and variable, which refers to how your funds are invested. In a fixed annuity, funds grow at a specified minimum rate of interest during the annuity’s “accumulation” phase. In an indexed annuity, your funds grow based on changes in an index, such as the S&P 500 Composite Stock Price Index, with a guaranteed minimum contract value. In a variable annuity, you can choose where you invest your purchase payments, typically from a selection of mutual funds. The rate of return on your purchase payments, and the amount of the periodic payments you eventually receive, will vary depending on the performance of the investment options you have selected.
• People usually buy life insurance to protect their beneficiary from loss of income due to their death and to assist with final expenses. People usually buy annuities to protect themselves (and possibly their spouses) from outliving their assets.
• Generally, a life insurance policy pays one lump-sum benefit at the death of the insured. Annuities usually make periodic payments for a specific amount of time, as detailed in the contract. This may be for the rest of your life, or the life of your spouse or another person. Like a life insurance policy, however, the annuity has a death benefit. If you die before you start receiving annuity payments, the person you name as your beneficiary receives a specified payment.
• Both life insurance and annuities have tax advantages. Although annuities typically offer tax-deferred growth of earnings, when you take withdrawals from the annuity, they count as taxable income. In most cases, life insurance beneficiaries receive the death benefit free of income tax.
• A whole life policy builds a cash value that you can withdraw, without penalty or tax consequence, after it reaches a certain amount. If you withdraw funds from your annuity early, you may pay substantial surrender charges to the insurance company, as well as tax penalties.
Which is better, life insurance or annuities? Each has its advantages and place in a family’s financial plan. A licensed life/health insurance agent can help you evaluate life insurance and fixed annuities; an agent with a Series 6 or 7 license can also help you evaluate variable annuities and variable life policies. Please contact us for more information.