Life insurance vs. annuity: Key differences
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If you've been considering life insurance, annuities or both — but are confused as to how they work and which may be better for your financial plan — here are the basic facts: Both can be issued by a life insurance company, and both can enhance financial confidence and well-being in the years ahead. Beyond that, life insurance and annuities each play a unique role and have their own key benefits and drawbacks. To find out which may be more appropriate for you or whether you should consider purchasing both, take a minute to learn:
How does life insurance work?
How do annuities work?
What is life insurance?
According to Guardian’s 2023 Study - Employee Life Insurance Facts and Statistics, 84 percent of families who lost a wage earner without life insurance live paycheck to paycheck.* Life insurance provides financial protection that can help ensure that won’t happen to your family. In the event of your death, beneficiaries will receive a death benefit, which can help replace many years’ worth of income and cover a range of expenses from groceries to mortgage payments to college tuition.1,2
There are two basic types of life insurance:
Term life insurance provides coverage for a specified period, usually ranging from 10 to 30 years. Term policies provide a death benefit to your beneficiaries if you pass away during the term.
Permanent life insurance - whole life insurance or universal life insurance — costs more than term but provides coverage that lasts your entire life. In addition, permanent policies provide a tax-efficient way to accumulate assets.
What is an annuity?
An annuity is a financial product designed to provide a regular stream of guaranteed payments in return for your initial investment. Some annuities pay out for a predetermined number of years; others pay out over your entire lifetime. Lifetime annuities are especially popular with retirees and those planning for retirement because they provide a steady cash flow that can protect against the risk of outliving one’s savings.
There are two basic types of annuities — income and deferred
Income annuities usually start making regular payments within one year of your initial investment. When there is no delay in collecting income, an income annuity may also be known as an immediate annuity. Income annuities can be a good fit for people who are almost at or already in retirement.
Deferred annuities are often the preferred choice of those who are still years away from retirement and don’t need an immediate payout. With a deferred annuity, your investment grows tax-deferred until you start taking regular withdrawals in retirement, so the payout is usually higher than you’d receive by making the same investment in an immediate annuity. There are several types of deferred annuities including:
Fixed annuities offer a guaranteed interest rate with no market volatility – you know in advance how much your money will earn over time.
Fixed index annuities offer a guaranteed minimum return (like fixed annuities) but are also tied to the performance of a stock market index, giving them the potential for added growth.
Other types of annuities, such as Variable Annuities or Registered Index-Linked Annuities, may also be available and can be discussed with your financial professional.
The choice of a fixed annuity, variable annuity, registered index-linked annuity or fixed indexed annuity often depends on a person’s risk tolerance. Please discuss this with your financial professional before making your decision.
Life Insurance | Annuity | |
|---|---|---|
Primary Purpose | Provide an income tax-free payment or payments to beneficiaries in the event of policyholder’s death. | Provide a guaranteed income stream to annuity owner for a specified period or life. |
Payouts | Income tax-free payment or payments at time of policyholder’s death. | Guaranteed payments to annuity owner for agreed upon term and frequency. Death benefit to beneficiary under certain circumstances. |
Underwriting Requirements | Medical examination. | No medical examination required. |
Age of Purchase | Generally younger people with dependents. | Generally those approaching or in retirement looking for a guaranteed stream of income. |
Tax Considerations | Permanent life insurance offers the opportunity to accumulate cash value on a tax-deferred basis. Death benefit is usually income tax free for both permanent and term policies. | Annuities offer the opportunity to earn investment income or interest on a tax-deferred basis. |
Coverage Length | Term life insurance covers policyholder for the specified term — usually 10, 20 or 30 years. Permanent life insurance covers policyholder until death. | Annuities payments for the term specified at time of purchase. The term may be a set number of years, or until death. |
Potential Drawbacks | Term life insurance coverage is terminated at the end of the term. Permanent life insurance can be costly. Medical examinations typically required for both. | Some annuities may have high annual fees. Early withdrawal of funds may result in high surrender charges and tax consequences. |
Life insurance and annuities can help protect your finances in different ways
Both are designed to provide financial protection, but they serve very different purposes and have distinct features.
Life insurance is primarily intended to provide a death benefit to your beneficiaries in the event of your passing. The income-tax-free payment or payments can help them handle day-to-day living expenses and other financial responsibilities in the absence of your income. In other words, life insurance can help protect your family from the risk of losing your income.
While an annuity may be tailored to provide a payout to beneficiaries after your death, that’s not the primary purpose. Annuities are designed to provide a guaranteed stream of income to live on, typically in retirement. And with a lifetime annuity, that income is guaranteed to last as long as you live. So, an annuity can help protect you from the risk of outliving your money.
Which may be right for you? Possibly both
As you can see, life insurance and annuities serve different purposes and are appropriate for different people, depending on their circumstances and financial goals.
Life insurance is especially valuable for individuals who have financial dependents (spouse, children, etc.) and want to help ensure that their loved ones are financially protected if they can't be there to provide support. In addition to living expenses, life insurance can also help dependents cover your end-of-life costs and any debts or significant financial obligations. It can also be a valuable tool for business owners, who may use life insurance to protect their businesses and provide for succession planning. And permanent life insurance, in particular (universal or whole life insurance), can be important for people who want to build family assets and provide an inheritance to their heirs.
Annuities are most appropriate for retirees (or those planning for retirement) who want to ensure a stable source of income during their retirement years. Deferred annuities can also be a useful savings tool for younger, high-earning individuals looking for tax-deferred growth.
Annuities and life insurance serve different primary purposes, and many should consider purchasing both.
For example, a young, high-earning individual may need a life insurance policy to protect their family; at the same time, if they've maximized contributions to their tax-deferred IRAs and/or 401(k) plans, they could purchase an annuity and receive similar tax-deferred growth advantages. Some retirees may choose to purchase an annuity to help provide steady income payments during retirement while also maintaining a life insurance policy to provide support for their loved ones or cover outstanding debts in the event of their death. In addition, people with complex estate planning needs may use both annuities and cash value life insurance to achieve specific goals, such as helping to mitigate estate taxes, passing on wealth, or providing for charitable donations.
It's important to assess your financial goals carefully before purchasing annuities or life insurance. Speaking with a financial professional can help you determine the right financial product — or mix of financial products — to meet your individual needs and objectives.
Life insurance vs. annuity at a glance
Life insurance may be the right choice if: | An annuity may be the right choice if: |
|---|---|
You want to protect dependents who rely on your income (in the event of your death) | You want a guaranteed income stream in retirement |
You want to make sure that your end-of-life expenses are covered | You want to ensure that you don’t outlive your money |
You have children who plan to attend college and will need money for tuition payments | You’ve maximized your retirement account contributions and need an additional retirement savings vehicle that offers tax-deferred growth |
You don’t want your survivors to be held responsible for your outstanding debts or significant financial obligations | no |
You want to leave a monetary legacy for your survivors | no |
Guardian can help
If you have questions regarding life insurance or annuities, take the next step: talk with an experienced professional who will take the time to learn about your unique situation and explain the different options that may fit your needs and your budget. If you don't know a financial professional, ask your friends for a recommendation – or click below to find a Guardian financial professional in your area.
Frequently asked questions about life insurance and annuities
There is no one "correct" answer to the question of annuity vs. life insurance. They are two very different pieces of the financial puzzle, and one or both may be appropriate for you, depending on your needs and circumstances. A life insurance policy is primarily designed to provide financial protection to your beneficiaries in the event of your death. An annuity contract is typically meant to provide a guaranteed retirement income stream after retirement age. These annuity payments can help ensure people don't outlive all their savings.
While it's difficult to pick the biggest disadvantage of annuities, there are some drawbacks that you should be aware of. These drawbacks may include annual fees, costly surrender charges, and tax consequences should you withdraw your funds early. Also, it’s important to remember that annuities may provide lower overall returns than many alternative investment options.
Unlike life insurance policies, not all annuities pay a guaranteed death benefit. That said, in many cases, you can add a death benefit rider to ensure that if you pass away before your annuity payouts equal or exceed the amount you paid in, your beneficiaries will receive the balance. There are also ways to structure an annuity contract so that annuity income payments to your spouse continue after your death. Be sure to discuss the options with your financial professional prior to purchasing an annuity.
There is no single correct answer to this question. The monthly payout will vary depending on the type, terms, and length of the annuity in question. That said, a $50,000 annuity with a 5% annual interest rate and a 10-year term would pay approximately $530.33 per month. (This calculation assumes fixed monthly payments over the term of the annuity, with the interest rate compounded monthly.)
What happens depends on the terms of the annuity contract and whether a contingent (secondary) beneficiary was named. If a contingent or secondary beneficiary is listed in the annuity contract, they will receive the death benefit or remaining payments after the primary beneficiary's death. This ensures that the funds or benefits continue to pass to someone designated by the owner.
The death benefit or remaining payments typically become part of the deceased beneficiary's estate if no contingent beneficiary is named. The estate's executor will then handle the distribution of these funds according to the deceased's will or state intestacy laws if no will exist.