Insurance Basics 101: Annuities vs. Life Insurance

Annuities and Life Insurance both seek to address the needs of clients pondering how to provide for themselves and/ or their families with retirement and end-of-life expenses. These two types of investment products help policyholders plan for their future by saving money in the present, according to the specifications of their plans. To put it quite broadly, an annuity is a fund that individuals 40+ should consider. The funds paid into their schedule are redeemable tax-free after the age of 59 1/2, whereupon predetermined amounts disbursed to their accounts on a regular basis. In contrast, a life insurance plan does not pay out cash on a monthly or annual basis, except in cases of disability or illness. Both plans are instrumental in ensuring one’s future financial health, yet it’s important not to conflate the two and annuities offer more comprehensive options for most consumers.

Financiers unveiled annuities in the marketplace when investors began to notice that life insurance policies indeed helped eliminate end-of-life costs for clients. Life insurance would cover, say, the funeral expenses or help a spouse continue to pay off a mortgage. Tragically, however, a situation arose where many individuals were outliving their money. If one cashes out their life insurance policy early for some income, then they encounter a dramatic surrender value, or a steep fee. The insurer charges them for ending the policy before it matures. Though there are several types of life insurance policies, many have fallen into what is called the “term trap.” Clients buy term life insurance at a young age, for a low price, and renew this policy on an annual basis. As the clients age, the premiums become so costly that some can no longer afford them and the policy lapses.

With annuities, an insurer (through a licensed insurance agent) and a client make a contract. The insurer pays the insured (the annuitant) according to a specific schedule. The client and agent review the client’s financials goals and financial state, then determine a schedule of payments. One type of annuity is the fixed index annuity, where part of the fund goes towards been invested in stable government bonds or an indexed market. The insurance company uses the earnings of this investment to allow the annuitant to make a profit in interest on their investment. The annuity is “fixed” because the insurer guarantees a payout or no penalty during down years.

Sounds too complicated?

Some investors prefer the single premium immediate annuity (SPIA), which simply requires a large, initial down-payment. The insurer and the insured agree upon installments of this initial investment (considered the premium) be paid out, say, monthly or annually for the rest of the client’s life. SPIA contracts are usually for life or period certain that may exceed 10 years. Although SPIAs are common forms of annuities, MYGA (multi-year guarantee annuity) is the most simple type of annuity on the market. With a MYGA, the annuitant and insurer enter into a contract for 3-10 years. Similar to a fixed index annuity, the insurer invests money into the market. However, with this type of contract, the insurance company guarantees the insurance rate will remained fix for a period of time. Some annuities can fluctuate in value, but usually have a guaranteed floor that prevents one from going negative during a loss year. MYGA is a popular choice because the stable interest rate helps clients with specific financial goals.

The final type of annuity worth mentioning is the differed income annuity, a product that came on the market in 2011. To buy this product, one can either put down a lump sum or make a series of payments over the years that add up to said lump sum, and the insurer makes periodic payments to you. This product is different from the others in that the client can choose and alter when they receive payments. When circumstances suit them, they could switch from having a yearly payout to a monthly payout. Just as with annuities themselves — as opposed to life insurance — flexibility in managing money late in life is nowhere more visible than in differed income annuities.

For the right situation, annuities can be the best financial product.

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