Life insurance and annuity contracts are two completely different concepts. On the one hand, life insurance aims to provide the insurance owner’s family with a lump-sum payout when the owner passes away.
On the other hand, annuities are long-term investment that provides the individual with guaranteed income payments. Both life insurance and annuities are tax-deferred retirement plans. They are great alternatives to bond and stock investments.
How does life insurance work?
Life insurance provides financial protection for your loved ones. Life insurance provides benefits and financial aid to your beneficiaries and loved ones with cash payments when you pass away. Your family or loved ones can use the money as they want.
They can use the money to provide for themselves, maintain their standard of living, pay off their loans or fund their education. As a general concept, when you purchase life insurance, you pay a monthly premium, and your beneficiaries receive a lump sum money after you pass away.
How do annuities work?
An annuity is an ideal solution for your retirement age as it guarantees you will receive a fixed amount of money every month for the rest of your lifetime. Annuities help protect retired people by guaranteeing them a constant income stream they can rely on till they die.
When you purchase an annuity, you submit a lump sum of money which is then returned to you in monthly payments. Depending on you, the payments can start immediately or at a later time. You can ask your financial professional about the immediate annuity rate as well as what rate would apply later on.
Annuities work in the complete opposite way as life insurance. Life insurance provides for your loved ones after you pass away, while annuities provide guaranteed monthly payments to you so that you do not have to worry about outliving your savings.
Life insurance
As mentioned above, life insurance safeguards your beneficiaries after your death. There are many different types of life insurance, including:
Simple term life
A simple term life policy provides death benefits to the individual’s loved ones.
Permanent life
Also known as cash-value policies, permanent life insurance offers a saving component. This is why the premiums have substantially higher fees than those with commensurate term policies.
Whole life
Whole life insurance policies offer benefits to the policyholders. The insurance company gives the policyholders cash accounts based on the investment portfolios.
Variable life
Variable life insurance policies offer growth potential by allowing policyholders to choose different bonds, stock and market funds and to invest in them. However, variable life policies are risky as they are affected by the performance of the investments.
The money in the policyholder’s bank account grows tax-deferred. Unlike other common investments, consumers do not have to pay taxes until they withdraw the funds. Variable life policies also offer much greater spending flexibility.
A little more detail about life insurance
It is important to know that using life insurance as an investment has its drawbacks, such as high fees. Half of the premiums you pay go to the sales representative’s commission. This is why it takes a bit of time for the savings to begin.
In addition to the upfront costs, insurance holders have to pay yearly administrative and management fees, which cancel the benefits of the tax-deferred growth of funds.
Moreover, it is usually unclear what the fees are, making it difficult for potential investors to compare different providers in the market. Most people cancel their contracts within the first few years as they are unable to meet the harsh payment schedules.
Many financial professionals urge investors to purchase cheap insurance policies in order to save the leftover funds from being invested into permanent life premiums. This tactic allows policyholders to pay less investment fees while enjoying tax-deferred growth to its fullest.
A little more detail about annuities
Most people fear that they do not have enough savings to get them through their retirement years. Annuities were created to help those individuals with such concerns.
An annuity is a contract with an insurance agent where you pay a lump sum to the company, and then you receive monthly payments for the time period mentioned on the contract.
Some types of annuities offer lifetime payment streams. The number of types of annuities available has increased over the years, including:
Fixed annuities- You submit a lump sum and then get a fixed guaranteed amount of payouts for a particular period of time.
Variable contracts-You submit a lump sum, but the amount of money you get back depends on how the market performs. They are risky and affected by fluctuations in the stock market.
Indexed annuities- They are a hybrid of fixed and variable annuities.
What you should know about annuities
Annuity contracts charge a large commission fee that can overlook the long-term benefits. They also charge really high surrender fees, which is a penalty investors have to pay for withdrawing money before the mentioned time or canceling the contract altogether. If you are someone who is comfortable with their money being locked away for years before being able to use them, then you should look into getting an annuity.
Most types of annuities grow on a tax-deferred basis, but if the investor withdraws money before they reach a particular age, then any investment gains will be charged the capital gains taxes. This is why annuities are ideal for individuals with a long life expectancy and who are likely to reach the age of 90 years.
Non-qualified and qualified annuities
The above-mentioned type of annuities falls under the non-qualified type of annuities. On the other hand, qualified annuities are those that are held in IRA( a tax-benefited retirement plan).
Simply put, a non-qualified annuity is funded with post-tax dollars, and a qualified annuity is funded with pre-tax dollars.
Qualified annuity contracts are subjected to withdrawal charges and RMD rules, as are many other investments.
The bottom line
Most people confuse annuities with life insurance. In reality, they are worlds apart. Life insurance is a great way to provide for your loved ones after your death. At the same time, an annuity is a great way to provide for yourself during the post-pension age.
