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Annuities vs. Life Insurance: Key Differences

SmartAsset: Annuities vs. Life Insurance

You may want to consider both annuities and life insurance for your long-term financial plan. Essentially, you purchase life insurance in the event you die sooner than expected and you buy an annuity in the event you live past your retirement savings. Both options have their benefits and downsides. The following overview will help you discover which one might be best for your unique financial situation.

A financial advisor can help you create a financial plan for your retirement needs and goals. 

What Is an Annuity?

An annuity is an insurance contract that provides income to you during your retirement. In exchange for a lump sum payment or series of payments, you’ll receive a set income starting at a set time. While there are many variations of annuities, fixed annuities, variable annuities and indexed annuities are some of the most common contracts.

With a fixed annuity, you receive a guaranteed interest rate in exchange for a certain amount of money. With a variable annuity you can select the investments you put into the contract. These investments will determine your interest rate throughout the contract. Lastly, an indexed annuity earns a return that is pegged to a market index such as the the S&P 500.

Conservative investors tend to feel more comfortable purchasing fixed annuities since they are more risk-averse. Younger or more experienced investors may choose a variable annuity so they can potentially reap the benefits of higher gains if their investment selections do well.

Pros and Cons of an Annuity

Annuities are usually complex financial products. However, they tend to be flexible and don’t have the contribution limits you may see with a 401(k) or IRA. And they still offer tax-deferred growth.

Essentially, if you started planning for retirement later in life, you’d be able to put more money away for retirement. Since you’re able to put more tax-deferred money away for your retirement, it may grow before it comes time for you to hang your hat and retire.

One of the biggest disadvantages of purchasing an annuity is they often have high fees. Since insurance brokers sell annuities, they tend come with a high commission – often close to 10% of the entire contract. Annuities also may come with surrender charges, which are fees for taking money out of the contract before it matures.

Even though surrender fees tend to decrease the longer you hold the policy, they can still chip away at your returns. In other words, you may have been better off contributing to another retirement saving vehicle such as an an IRA.

What Is Life Insurance?

SmartAsset: Annuities vs. Life Insurance

Life insurance is a contract between you and an insurance company that provides a lump sum of money to beneficiaries of the policy when you die. Policyholders exchange premium payments to the insurer with the promise that the insurer will give beneficiaries a sum of money known as a death benefit. That money can, among other things, help pay for funeral expenses.

There are two common types of life insurance: term life insurance and permanent life insurance such as whole or universal insurance. Term insurance offers coverage for a certain amount of time such as 10, 20 or 30 years. Permanent insurance offers coverage for your entire life. Most of the benefits of these policies are typically tax free.

Many life insurance policies also offer a cash value and income-earning options. You can also add other living benefits such as critical care options. If you find yourself in a financial bind, it may put you at ease knowing you can tap into your cash value at any time. However, when you die, your beneficiaries will not receive the cash value; instead, it will go to the insurer.

Pros and Cons of Life Insurance

An advantage of life insurance is that you may not have to pay taxes if you make a withdrawal. Many policies allow you to borrow against your contract depending on the contract you choose. This means, if you repay your loan, your death benefit will remain the same.

Also, if your main concern is making sure your family is taken care of if something were to happen to you, buying a life insurance policy can put you at ease.

Like annuities, the assets in the account are tax-deferred but can come with hefty fees. Additionally, the premium payments can become a bit of a burden. These payments often go towards maintenance fees and administrative fees. Since premiums can become a burden many policyholders cancel their contract.

If you cancel your policy, you may lose all the contributions you have made thus far. As a result, investors may see little to no return on their investment. In this case, it would have made more sense to contribute to a retirement savings account instead.

Key Differences

SmartAsset: Annuities vs. Life Insurance

As illustrated above, annuities and life insurance seem to have different goals. Life insurance is used to help your family due to unexpected loss while annuities act as a safety net by providing a guaranteed income to retirees.

Even though both products have the potential to earn returns, it’s wise to take a deep dive into the terms and restrictions of each product.

How to Select the Right Policy

The most important factor in determining which policy is right for you is to decide the goal of the contract. For example, if you want to make sure your children are taken care of and pay for funeral expenses when you die, consider some form of life insurance.

Conversely, if you want a secure stream of income in retirement you may consider an annuity since it offers tax-deferred savings and steady income. Both plans may provide some form of a death benefit, but each option may vary drastically depending on what plan you’re considering. If you’re still unsure, you may want to consult a financial advisor who can help you review all your options.

Bottom Line

When it comes to planning for retirement, investors may want to consider an annuity or a life insurance policy. An annuity provides a secure stream of income during retirement while life insurance protects your loved ones financially if you die unexpectedly.

But keep in mind, annuities and life insurance policies aren’t the only options to help you plan for retirement. Other options such as IRAs may be more suitable for your unique financial situation.

Tips for Retirement Planning

  • Consider talking to a financial advisor about annuities and life insurance and if either or both should be part of your retirement planning. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Before you get an annuity or a life insurance policy, you should know how much money you’ll need in retirement and whether you’re on pace to meet your goals. Get an estimate with SmartAsset’s free retirement calculator.

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