What’s the Difference Between Life Insurance and Annuities?

Although annuities may be one part of a comprehensive retirement savings and estate plan, they’re not primarily intended to function as an alternative to life insurance. Annuities are ideal for paying you either a lump sum or a stream of income while you’re still alive, while a life insurance policy is solely intended to pay a predictable amount of money to your beneficiaries at the time of your passing.

Do Annuities Pay Anything to Beneficiaries?

It depends on the annuity and the terms stipulated in your contract. If the contract includes death benefits, then the annuity holder can name a beneficiary. Some annuities will pay out the balance of the annuity to a named beneficiary. However, beneficiaries are often not paid the full value of the annuity, especially if the annuity didn’t have a finite pool of money. Instead, many annuity contracts include a guaranteed minimum payment for beneficiaries.

There’s also a difference between bequeathing an annuity that has or has not matured.

For example, deferred income annuities go through “annuitization” wherein the annuity is converted into income payments. A surviving spouse or beneficiary may receive a lump-sum payment equal to the value of the annuity if the holder dies before annuitization, or they’ll receive a series of payments if the death occurs after annuitization. Conversely, depending on the contract, the beneficiary might receive spousal continuance if the holder dies before annuitization or nothing at all if the spouse dies after annuitization.

Can I Replace Life Insurance With an Annuity?

The death benefit rider on an annuity is key when judging the usefulness of an annuity as a way to pass wealth on to a beneficiary. The basic idea of an annuity is to provide income for the remainder of your life, not necessarily the remainder of your spouse’s life (unless they are a co-owner).

There are many different types of annuities and annuity policy options, some of which do provide for post-death payments. Investors who are interested in the potential for annuities as a tool for wealth transfer should learn about enhanced death benefits.

Annuities often feature one of two types of death benefits: a lump-sum payment or a percentage of continued annuity payments to the beneficiary.

Some death benefit provisions will stipulate a minimum guaranteed payment. In those cases, the beneficiary may either receive the remaining money in the annuity or the guaranteed minimum, depending on which is greater.

Beneficiaries may also have different payment options. They can either receive a single distribution or have the payout spread over five years to dilute the tax burden. Some annuities also offer “nonqualified stretch” benefits, which means the beneficiary continues receiving reduced payments for the remainder of their life. Some spouses may also have the option of becoming the new annuitant.

Are the Annuity Owner and the Annuitant the Same Person?

Not necessarily. The annuitant is the person whose life expectancy is the basis of the annuity. If a couple are co-owners of an annuity, they may choose the younger of the two to be the annuitant to stretch out the projected payments and reduce the tax burden each year.

How Are Annuities and Life Insurance Policies Similar?

There are quite a few parallels to be found between life insurance and annuities. Both pay out funds to holders or beneficiaries; the difference is based on when those funds are paid out. Both can serve as investment vehicles in which the money you put in either accrues interest or is invested in equities or indexes to grow over time. In the case of annuities, payments may end when you die, whereas payment on a life insurance policy won’t begin until you pass away.

Both have premiums based in part on your life expectancy, but the pricing is flipped. People with a short life expectancy or those with significant health risk factors may have to pay high life insurance premiums, while someone who is healthy and has a long life expectancy will have to pay high annuity premiums.

Annuities are primarily thought of as a retirement savings policy, while a life insurance policy is more closely associated with estate planning.

Should You Have an Annuity or Life Insurance?

For many Phoenix retirees and those looking into setting up an estate plan, having both annuities and life insurance polices may make sense. They are not mutually exclusive savings and estate planning tools.

If you’d like to learn more about annuities and life insurance, consider scheduling a consultation with the investment advisors and retirement planners at Fullerton Financial Planning. Give us a call at (623) 974-0300 to get started.