Differences Between Life Insurance and an Annuity
- Life Insurance is a product solution used to provide a death benefit to heirs after the death of the insured.
- Annuities are a product solution often used to provide a stream of income during the lifetime of the annuitant.
- Life insurance companies only offer both products since they are able to bet on both sides of the life/death coin.
The Benefits of Life Insurance
Life Insurance is a product solution used to provide a death benefit to heirs after the death of the insured. There are various reasons to purchase life insurance, but two of the most frequent reasons are to replace the loss of income or to pay off debt.
These policies provide a tax-free death benefit to the beneficiaries when the insured passes away. This death benefit can be used to pay off any outstanding debt, such as a mortgage or a large student loan balance. Also, the death benefit can be used to support the remaining family members if the insured was the primary income earner.
The Benefits of Annuities
Annuities are a product solution used to provide a stream of income during the lifetime of the annuitant. The annuitant will fund the product beforehand and then have the option to turn on the income benefit. There is a second category of annuities that are more growth-oriented. They do not have the goal of income for life but are more focused on appreciation, with the potential for no investment fees and protection of the initial investment.
The traditional sense of an annuity is the lifetime income benefit to help provide retirement income. Very few companies still offer pension benefits, so an annuity is a way for a retiree to create their own income stream. The taxation of this income benefit depends on whether the source of funds was qualified or non-qualified, but at least some portion of the income will be taxable in either case.
Other Things To Consider
Only life insurance companies can offer annuities based on risk assumptions. Life insurance is risky for the provider in case the insured passes away immediately, and it becomes the most profitable if the insured outlives the policy term. An annuity policy is risky for the provider in case the annuitant lives a long-time, such as 100 years of age or older, since this may result in an income benefit for 30+ years. Annuities are most profitable for the provider when the annuitant passes away right after turning on the income.
Only life insurance companies can offer annuities because they are essentially playing both sides of the same coin. They sell products that pay out when someone dies, but they also sell products that pay out when someone is still alive. The average life expectancy is getting higher and higher as advancements in the medical field continue. This means annuity providers will have to pay out income benefits longer, but it also means they will pay out less in death benefits from life insurance policies.
Which Solution Is Right for You?
This blog post is a very high-level breakdown of the comparison of annuities and life insurance solutions. Both product types offer a variety of different features for the owner to consider. Everyone has a unique situation, and meeting with a trusted financial advisor is important before making any significant financial decision. Life insurance is not always needed in every case, just as lifetime income is not always needed.
Speak with a Trusted Advisor
If you have any questions about our annuities or life insurance, taxes, your individual investment portfolio, our 401(k)-recommendation service, or anything else, please call our office at (586) 226-2100.
Please feel free to forward this commentary to a friend, family member, or co-worker. If you have had any changes to your income, job, family, health insurance, risk tolerance, or overall financial situation, please call us so we can discuss it.
We hope you learned something today. If you have any feedback or suggestions, we would love to hear them.
If you found our article helpful, consider reading our other recent posts on Charitable Gifting, Record Inflation, and Fiduciary vs. Financial Advisor.
Zachary A. Bachner, CFP®
with contributions by Robert L. Wink, Kenneth R. Wink, James D. Wink, and James C. Baldwin