Both annuity and life insurance offer solutions to several life needs, but what differentiates one from the other? Annuities offer a wide range of income to policyholders while they or their families are alive. While life insurance offers cash payment on the death of a policyholder. Annuity and life insurance are often mistaken for each other due to their similarities.
Annuity and life insurance are both offered by insurance companies; they offer different benefits and work in different ways. Annuities offer benefits while the policyholder is still alive, while life insurance offers payouts after the policyholder dies. However, annuities may offer insurance features that look like life insurance in some instances.
What is an Annuity?
An annuity is a type of insurance that offers a stream of income for a certain period, which is mostly for the life of the policyholder, helping them build financial strength. It ensures that policyholders never outlast their income.
Annuities pay income for a specific period indicated on the contract. This period often lasts 20 years or for the rest of the policyholder’s life, including their spouse. However, this contract is offered by insurance companies and can be taken with either a large payment or a sequence of payments over time. Most people often use this insurance as their retirement plan.
What is Life Insurance?
Life insurance is a type of insurance that offers cash payouts to beneficiaries after a policyholder’s death if the policy terms have been met. It requires the policyholder to pay premiums regularly, usually monthly, quarterly, or yearly, to their insurance company, and when the policyholder dies, it pays off these accumulated benefits to their beneficiaries. Life insurance comes in two main types, which are:
- Term life insurance: This life insurance offers coverage for a specific period, usually five to ten years and most times thirty years. If the policyholder lives more than the insurance life, the insurance company will not pay any death benefits.
- Whole life insurance: Whole life insurance, also called permanent life insurance, offers coverage throughout the policyholder’s life as long as they continue to pay premiums. It comes with various varieties that offer higher returns over the years.
These two types of life insurance offer different benefits and evaluate risks differently but ensure that policyholders are financially protected.
Annuity vs. Life Insurance: What’s the Difference?
While these two can be obtained from insurance companies, they are different in several ways. Understanding their differences helps you determine which is best for you. The following are differences between this insurance in terms of benefits, taxes, and quick access to your income:
• Policy advantages
Life insurance is generally more essential for creating an inheritance for your beneficiaries than an annuity. Over time, life insurance premiums turn into bigger death benefits after the death of a policyholder; this death benefit is received by the beneficiaries tax-free. Annuity death benefits are lesser compared to life insurance.
The beneficiaries would be responsible for income tax on the annuity investment income. For this reason, annuities, if best taken while you are still alive, offer higher returns because life insurance coverage is not paying off.
• Taxes
Income tax delays are common both with life insurance and annuities while your income remains in the contract. Life insurance allows policyholders to withdraw up to the amount that has been paid on premiums tax-free. If gains are withdrawn, the policyholder would own income tax with the insurance company.
Policyholders are also allowed to borrow their cash value and repay over an agreed-upon time frame with no income tax charged. However, annuity taxes are based on how the contract was purchased. If it was purchased using pre-tax retirement funds like 401(k) funds, your income would be %100 taxed.
• Quick access to funds
Life insurance allows quick access to funds, especially if it is needed for retirement. As long as cash value has been accumulated, policyholders are allowed to withdraw and borrow anytime it is needed. There are no age requirements for this process to be carried out.
However, with an annuity, you and the insurance company will agree to keep your funds for an agreed time frame. If a large amount is withdrawn or canceled before time, the insurance company will charge a sizable surrender fee.
Can Life insurance be converted to an Annuity?
Yes, life insurance can be converted to an annuity if it has accumulated cash value. The annuity will invest and generate funds based on your life insurance cash value balance, while your life insurance death benefits would be given up for more funds and investments. However, an annuity cannot be converted to life insurance.
