As you think about how you want to approach planning for retirement, you’ll need to make decisions about how to manage financial risks and income. Annuities and life insurance policies are both excellent tools for doing that, but they serve different purposes.
When it comes to comparing annuity vs. life insurance, you’ll first need to understand how each works and the issues they’re designed to address. This can help you make a decision about whether one or both of these products can help you.
What Is an Annuity?
An annuity is a type of financial product that, similar to life insurance, is a contract issued by an insurance company. As the annuity holder, you pay into the annuity either all at once or over time, and you’ll receive fixed or variable payments in return.
There are different types of annuities, and each type has its own characteristics, but because they are contracts, you can tailor them to fit your needs. Each insurer offers its own ways to customize your annuity by adding contract addendums called “riders” that allow you to modify the base policy.
Types of Annuity Contracts
The main purpose of annuities is to provide a way for you to receive a guaranteed stream of payments. Your payout can be guaranteed for your life (regardless of how long you live), or it can be broken up into payments provided over a fixed period. Each type of annuity pays out in a slightly different manner.
- Immediate annuities begin paying you within six months of the time you purchase the contract.
- Deferred annuities allow you to buy a contract now but delay receiving your payments until later. During this time, your annuity may grow, increasing the size of your payments.
- Fixed annuities earn a fixed interest rate, much like a certificate of deposit. You don’t have to worry about investment performance, but they often don’t grow as much or as quickly.
- Variable annuities allow you to invest your premiums and earn a market-based rate of return. Your annuity may grow but could lose value if the investments perform poorly.
The Purpose of Annuities
In retirement, it’s important to manage your savings effectively. This requires balancing your withdrawals and your income so you can cover your expenses without risking spending your money too quickly and running out. This would be easy if you knew ahead of time how long you would live and how much your investments would earn. Of course, neither of those things can be known, so you have to navigate retirement spending with some uncertainty.
This is where guaranteed income can help. Most people already have some guaranteed income thanks to Social Security. You may also have a pension. The monthly checks you receive from either of these do not depend on markets but are guaranteed by the government or employer that provides them.
Annuities are similar in that they provide a guaranteed payout, often for life. This protects you from risks, like:
- You won’t run out of money if you live longer than expected because the payments are guaranteed. That’s why they’re also called longevity insurance.
- If you have unexpected expenses that cause you to deplete your savings sooner than planned, you’ll still receive your payments.
What Is Life Insurance?
Life insurance can help protect your dependents in the event that you pass away. A life insurance payout can ensure they aren’t left without support that they may rely on you for.
For example, assume both you and your spouse are retired and collect Social Security benefits. When you pass, your spouse will not continue to receive both their and your Social Security payments. A life insurance policy can help replace that lost income.
Types of Life Insurance
All types of life insurance can provide a death benefit to your beneficiaries. However, some may also accumulate a cash balance. You can use that cash balance for your own needs while you’re still alive by borrowing or withdrawing from it.
- Term policies are in force for a defined period, such as 10 or 20 years. They do not build cash value. When the term ends, you no longer have coverage.
- Permanent policies are in force as long as you maintain them. In addition to the death benefit, they can also accumulate a cash value that you have access to.
The Purpose of Life Insurance
Life insurance primarily aims to protect living dependents from the loss of income or resources provided by the deceased. This can be a valuable part of a comprehensive retirement plan, especially when a significant portion of the total income is tied to one spouse.
The cash value of permanent policies can also provide more flexibility and liquidity, since you can borrow or withdraw from your policy as needed.
How Are Annuity vs. Life Insurance Taxed?
You will owe income tax on your annuity payments, but you usually don’t have to pay taxes on proceeds from life insurance policies. However, you may pay taxes on life insurance if you borrow or withdraw from the cash value of a whole life policy.
Annuity Taxation
The growth on your annuity is tax-deferred, similar to retirement accounts. You won’t have to pay taxes on your annuity until you withdraw from it. Annuities are categorized in two ways when it comes to taxes:
- Qualified annuities are purchased with money from a retirement account, like a 401k or an IRA. Your entire payment is taxed.
- Nonqualified annuities are funded by money that’s not from a tax-deferred retirement account. You will only owe taxes on the gain.
Life Insurance Taxation
When the death benefit is paid to a beneficiary, there are usually no tax liabilities. However, you may owe taxes on your life insurance policy if you withdraw from the cash value.
- You can borrow from your life insurance cash balance without having to pay taxes on the amount withdrawn as long you pay it back.
- The interest you earn on your cash value is tax deferred.
- The amount you withdraw from your policy may exceed the premiums you have paid. When that happens, you will owe taxes on the additional amount.
Learn More and Get Help
Life insurance and annuities are tools that can help protect you from risks in retirement. Annuities primarily protect you from the risk of running out of money, while life insurance aims to protect your beneficiaries. Whether you need one, both, or neither depends on how you want to balance your resources and address the risks you may be exposed to.
We’re Here for You!
Bankers Life is here to help customers with their financial and insurance needs. Please visit us at BankersLife.com to learn more.
Bankers Life Securities, Inc., Bankers Life Advisory Services, Inc., and their representatives do not provide legal or tax advice. Each individual should seek specific advice from their own tax or legal advisors.
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.
Bankers Life is the marketing brand of various affiliated companies of CNO Financial Group including, Bankers Life and Casualty Company, Bankers Life Securities, Inc., and Bankers Life Advisory Services, Inc. Non-affiliated insurance products are offered through Bankers Life Securities General Agency, Inc., (dba BL General Insurance Agency, Inc., AK, AL, CA, NV, PA).
Securities and variable annuities offered through Bankers Life Securities, Inc. Member, FINRA/SIPC (dba BL Securities Inc., AL, GA, IA, IL, MI, NV, PA). Advisory products and services offered by Bankers Life Advisory Services, Inc. SEC Registered Investment Adviser (dba BL Advisory Services, Inc., AL, GA, IA, MT, NV, PA).
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk.
Investments are: Not Guaranteed—Involve Risk—May Lose Value.
