What Is Life Insurance Annuity | How To Use This Versatile Investment Product
For the most part, life insurance plans help you prepare for the inevitable. When you die, the payout from your life insurance provides income for your loved ones and protects them financially.
However, planning for the future isn't just about what happens after death. Most people want to retire comfortably and enjoy benefits while they’re alive.
The good news is that you can receive a fixed income stream when you’re retired – you just need an annuity. Whether you want to create a financial cushion upon retirement or after you pass away, an annuity may be the right choice for you. Learn all about how these financial contracts can help you achieve your financial goals.
What Is An Annuity?
Annuities have multiple uses. For one, they can provide guaranteed income for life – ideal for individuals seeking long-term, tax-deferred growth, or retirement planning, and estate planning solutions. By making a single payment or series of contributions, you can get these funds back from your insurer. The principal you put into an annuity is known as its cash value.
With an annuity contract, how long you decide to distribute the funds is entirely up to you. You can set a fixed period, such as 15 years, or organize payouts for the rest of your life.
In life insurance terms, annuities can also refer to how you or the beneficiary decide to disburse your benefits on a life insurance policy. Life insurance can be paid out all at once or as an annuity over a fixed period.
How Does An Annuity Work?
Annuities for retirement convert a lump-sum premium into a steady stream of income through its tax-deferred accumulation period. During this period, your cash value builds up. Over time, they become highly adaptive retirement plans that you can customize to suit your immediate or future needs.
Your life insurance company takes on all the investment risk, thus charging fees for investments, riders, and other unique features or administrative services.
Free-look period: During the free-look period, you can pull out of your contract without paying a surrender charge.
Beneficiaries: If you plan to leave a portion of your annuity to a family member, you can purchase a death benefit rider on your plan and name them as beneficiary.
Riders: When it comes to riders, there are dozens that you can choose from. Riders range from disability income, guaranteed minimum cash value withdrawal benefits, and return of premiums. Remember that riders come at additional cost, so you'll want to select them carefully.
Types Of Annuities
Retirement annuities are a diverse product that can be used for various purposes, including paying for a new home or supplying income for monthly expenses. The type of annuity you select will depend on your financial goals and retirement plan.
Below are the primary methods for receiving income from annuities.
Immediate vs Deferred Annuity
Some people prefer to start receiving their disbursements immediately, while others start disbursements at a future date. The choice between immediate or deferred annuities depends on your financial goals.
Immediate Annuity: The only way to purchase an immediate annuity is through a lump-sum. Annuitants can receive the payments monthly, quarterly, biannually, or yearly. The interest rate on an immediate annuity is either fixed or variable according to inflation.
One significant drawback to this option is that payouts stop when an annuitant dies. Life insurance companies are entitled to the remaining amount.
Deferred Annuity: Deferred annuities disburse payments on a specified date, up until which they collect interest on a tax-deferred basis. You can select between fixed, variable, and indexed appraisals that all promise guaranteed rates of return. Though deferred annuities protect your principal, they come with surrender charges and can cost you investment opportunities.
A fixed-period annuity pays out at a fixed interest rate over a select number of years. Typically, policyholders plan to receive retirement income over 10, 15, 20, or 30 years. You can start receiving your disbursements immediately or after a deferred period.
Fixed annuities are straightforward and predictable, which is why they are the most popular form of retirement savings. They also don't depend on investment and stock, which means you won't lose money if the market underperforms.
The downside to a fixed annuity is that they can lose value over time because they don't keep up with inflation. Plus, if you aren't happy with the interest rates, you can only withdraw your money after the age of 59-and-a-half without penalty.
Variable annuities are an excellent way to grow investment income. Unlike its fixed counterpart, a variable retirement annuity undergoes an accumulation phase, during which you can decide how and where you want to invest your money.
These annuities earn interest according to market trends, increasing payments if stocks perform well. But even if your variable annuity performs poorly, you continue receiving payments for the duration of the payout. You can also provide them as a death benefit to dependents if you die before you start receiving your investment income.
However, variable annuities have no guaranteed return and the savings component isn’t tax-free upon withdrawal. They also come with costly administrative fees and a sales commission.
Like a variable annuity, a fixed-indexed plan earns interest. An indexed annuity accumulates money based on the performance of a stock index, such as the S&P 500, which means your annuity value increases as your stock index improves. Insurers often set a minimum growth rate as well, so you don’t have to worry about stock market dips negatively impacting your cash value.
However, the indexed variant doesn’t come without its downsides. As with other types of annuities, an indexed contract comes with surrender charges. Due to high sales commissions, additional fees, and a lack of transparency, you risk losing gains. In the later years of your contract, you also become subject to a cap on your annuity's increasing value.
Are Annuities & Life Insurance Different?
Whole life insurance policies and annuities are not the same things. The purpose of whole life insurance policies is to provide your beneficiaries with financial stability after your passing with death benefits. On the other hand, annuities provide lifetime income streams to the policyholders themselves.
However, you can distribute your benefits from a life insurance policy through an annuity. This means you can provide income for years even after you die.
If you’re relying on a life insurance policy to secure income for the future, purchase a whole life insurance contract (also known as cash value life insurance). Otherwise, you can purchase an annuity if you have ample room in your budget.
When An Annuity Makes Sense
Annuities are a great way to drive retirement income into your pension plan or provide a managed death benefit to your life insurance beneficiaries. Annuities can also work to your advantage under the following circumstances.
You Need Added Income
Chances are, your Social Security and savings aren’t going to be enough to sustain you in retirement. If you set it up to do so, annuities pay out for the remainder of your life, so you won't have to worry about outliving your money.
If you want to cover your spouse, you can do so with a Joint and Survivor account. As the primary annuitant, you'll receive the income and pass on the remainder of the money to the secondary account holder after your death.
You Prefer Customizable Life Insurance Products
If you value versatility, annuity products make for great retirement income options. You can tailor-make your contract according to your financial health and discuss with your investor what makes most sense according to your goals. If you so desire, you can also provide income for your dependents even over multiple generations.
You have full control over the type of plan, terms, and variations on your annuity payments. For instance, if your dependents aren’t financially equipped to handle a single sum, a death benefit distributed through an annuity can make the sum more manageable. If you have more than one financial goal, you can create a highly diversified investment plan as part of your life insurance policy.
You Want Tax Benefits & Principal Protection
One of the greatest advantages that come with an annuity is the ability to grow your money tax-deferred. Whatever dividends, interest, and capital gains you earn will remain tax-free in the account until you choose to withdraw from it.
When You Shouldn't Get An Annuity
Overall, an annuity is most ideal for individuals who feel their savings won’t allow for a comfortable retirement. However, there are some instances in which an annuity may not be the best option for you. If any of the following circumstances apply to you, it’s best to work out another plan with your life insurance company.
You Can't Shoulder Large Fees & Taxes
Annuities, especially variable annuities, can become expensive. Sometimes, they aren’t worth the cash value. You’ll have to pay costly administrative fees and other hidden charges from your lender. Your life insurance company might charge an expense fee to cover the costs of insuring your funds. However, these charges can take up as much as 1.25% of the account’s value.
You Have to Cover Multiple Expenses
The truth is, there are a lot of end-of-life and long-term expenses that your beneficiaries will have to shoulder – your funeral service, unpaid debts, existing mortgages, and medical care are just a few. Plus, your beneficiaries may also be struggling financially due to the loss of your income.
If you want to ensure that your final expenses are covered, leaving a single sum from your life insurance policy makes more sense than monthly annuity payments.
You Might Withdraw From It
Many life insurance products allow policyholders to withdraw their principal amount, if necessary. However, early cash value withdrawal fees are often steep, and it might not be worth it depending on the amount you’re trying to withdraw.
In many cases, annuities are an excellent way to secure income for when you retire. They are adaptable and provide tax-deferred lifetime income for you and your loved ones. Annuities are also an excellent way to customize your death benefits payout on a life insurance contract.
Along with your life insurance policies, annuities are a useful part of your estate planning. When shopping for one, always compare quotes from more than one life insurance company, and research accurate information that can help drive your decision.
If you’re planning for retirement or looking into options for life insurance policies, consult with Wesley Financial Group. We can help you figure out if annuity contracts suit your financial goals.