People need to have a retirement plan. One way to achieve that is by choosing a life insurance or an annuity. They are more of the same, but you need to learn their difference to know the best choice for you and your loved ones.
An overview of life insurance vs. annuity
Permanent life insurance seeks to compensate the beneficiaries with a lump-sum of money upon the premature death of the individual. However, annuities contracts provide beneficiaries with a lifetime of income streams.
If you choose a life insurance plan, your family only benefits if you die prematurely. The plan can either be divided into term-life or whole life insurance. The term life covers a specific period like 10, 15, 20, or so years. The whole life insurance policy covers the entire life of the policyholder beneficiary. Some term life policies can be renewed to become whole life plans when the term expires.
The main goal of the life insurance policy is to care for your dependents once you are gone. Some may involve the critical coverage option.
There are several types of life insurance policies. They are:
- Simple term life – the individuals loved ones receive the death benefit payment.
- Permanent life – this cash value policy adds a savings component. Individuals pay higher premiums than for commensurate term policies.
- Whole life – this policy allows insurance companies to credit policyholder’s cash accounts based on their performance on relatively conservative investment portfolios.
- Variable life – with this policy, there is a potential to grow the policy where stakeholders are allowed to choose bonds, stock, and money funds to invest in. There is, however, a risk when investments underperform.
Once the money is put in an investment/cash account, the money is not subjected to taxes. Taxes are only applied when the funds are withdrawn. Policyholders enjoy flexibilities like taking tax-free loans to cater for unexpected needs. That will not compromise the full death benefit as long as the money is paid with interest incurred.
There are a few drawbacks to investing in a life insurance policy. You pay high fees to cater for the representative’s commission. That can cover like half the amount saved. It takes time for the savings component to gain course.
You pay huge upfront costs, annual administrative fees, and management fees, which interfere with the tax-sheltered growth. For many people, the benefits lapse only a few years as they cannot pay the step payment schedules.
It is wiser for policyholders to choose lower-cost term insurance policy. They can put the extra cash into tax-advantaged plans like the 401(k) s or IRAs. They will enjoy lower fees and tax-differed growth of their accounts.
Some high-net-worth individuals use park cash value policies in irrevocable life insurance trusts to minimize their beneficiaries’ estate taxes that can be up to 40%
Annuity plans provide income at retirement if the owner of the plan lives beyond the expected lifespan. They benefit from tax-deferred savings on retirement income. Beneficiaries get the death benefits along with taxes. Annuities can be immediate, deferred, or longevity annuity plans.
- Deferred – the premiums are paid, and the income is deferred until a later date. Deferred annuities can either be Variable annuity or the Fixed Index Annuity. These two mainly differ in how interest is earned and whether one is seeking a safe investment or market-like returns.
- Immediate – these annuities pay their benefits in under one year from when you start paying premiums to your insurance company. You can but these annuities in a one-time, lump-sum. It is the best plan for those seeking a guaranteed income in their lifetime.
- Longevity – this fixed income annuity is issued at any age, and the income is deferred up to 45 years. It does not plan out until the holder is 80 years or more. You can consider it as a supplemental pension plan to boost your regular retirement plan.
Why would you consider a life insurance annuity?
Choosing annuity means that the death benefits will be split into many payments across several years of their choosing. Instead of accepting the lump sum payment, the beneficiary can use the lump sum to purchase an annuity through annuitization.
Life insurance annuity is less preferred to lump sum because, in most instances, the lump-sum is tax-free. The annuity payments are also tax-free. You can choose annuity if you have fewer expenses when you are retired. An annuity is suitable if you need to restrict your spending habits. Combined annuity payments are better off than receiving the lump sum that could easily be mismanaged. You can choose an annuity to pay you for the rest of your life.
However, before you choose this plan, speak to a certified financial advisor to inform you about the risks and benefits of taking annuity or converting life insurance into an annuity.
The risks of annuities
Some annuities might take very long to be released entirely. If you are old, you are going to collect less cash, and in case you die, the entire amount is paid out. It’s mostly a win for the company. With an annuity, you are not allowed to withdraw your principal earlier, or else you have to pay a steep withdrawal fee.
With an annuity, you are denied the liquidity in return for a higher rate of return. Sometimes it is advisable to take the lump sum and seek assistance from a financial manager on how to spend it. Annuities also place you at risk of paying fees that don’t exist.
Why people choose the lump sum death benefit
Find out how much coverage you need to keep your family running when you are gone. Consider mortgage, Medicare care, and tuition, among others. Consider your funeral expenses and possible medical bills from the cause of your death. On average, individual life insurance covers $500,000 to 1 million. The beneficiary must claim the lump sum, so they don’t get behind their bills. Remember, the death benefit is tax-free.
How to choose the right plan for you
It would be best if you chose between an annuity and life insurance. If you are purposed at helping your dependents, choose life insurance as it is tax-free for your beneficiaries.
If you are seeking a retirement payment plan, choose annuity as it provides tax-deferred savings with retirement income.
Life insurance protects your loved ones upon your death, while annuity protects your retirement income if you live longer than that you expect. However, seek professional advice to know the best plan to choose.
Where to buy annuity/life insurance
You can choose from the many reputable companies that offer annuity and life insurance plans. Use an insurance agent to find the best company or do it on your own. Compare rates of the best-rated companies that offer both plans and settle for the best. You can also contact us to help you choose the best options for you.