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If you want to secure your family’s financial future, you can consider a life insurance policy or an annuity. But you may have some lingering questions about which option to choose — and what makes them different in the first place.
In this article, we’ll explain how annuities and life insurance differ, and give you some practical advice to help you choose the right option for your specific situation.
What is an annuity?
Annuity is a type of contract between the policyholder and the insurance company. There are many types of annuities, but they all seek to provide monthly income while the annuity owner is still alive. The cost of annuity depends on the type and provider.
One downside to annuities is that they often charge fees, which can drive up the cost significantly. They can also be difficult to get rid of, and you may have to pay high surrender fees if you want to dissolve the annuity.
Customers often buy annuities because they want the security of guaranteed payments. Traditional stock market investing does not provide any type of guarantee, which can make consumers look risky.
Unlike life insurance, an annuity makes payments only if the owner is alive. If you die, the annuity will end. Consumers who are concerned about exhausting their retirement savings can buy an annuity that has guaranteed payments.
“If you expect your costs to remain stable and don’t want to worry about stock volatility, annuities can give you peace of mind,” said Noah Damsky, CFA at Marina Wealth Advisors.
What is life insurance?
A life insurance policy will provide death benefit to your heirs if you die while the policy is in force. If you have people in your life who depend on your income, life insurance can help them survive financially after you are gone. Most people buy life insurance if they have a spouse or child who needs their income.
Some employers offer life insurance policies as a workplace benefit, but you can also purchase life insurance through a third-party company.
types of life insurance
There are three main types of life insurance: term, whole and universal. Understanding how the different policies work is key to choosing the one that’s best for you and your family.
term life insurance
Term life insurance is given for a specific period, usually from 10 to 30 years. During that period, you will make equal monthly payments to the insurance company. If you die during the term, your heirs will receive the full payout.
The monthly premium for term life insurance depends on your age, gender, health and other factors. The older you are, the more you have to pay.
According to insurance broker PolicyGenius, the average monthly premium for a 35-year-old man is $30.14 per month for a 20-year, $500,000 policy. The average monthly premium for a 35-year-old woman is $25.43 for a 20-year, $500,000 policy.
whole life insurance
Whole life insurance is designed to protect you for your entire life. As long as you continue to make monthly premiums, your beneficiaries will be eligible for payments.
Because whole life policies are supposed to last your entire life, the premiums tend to be much more expensive than term life policies. According to PolicyGenius, a whole life policy for a 35-year-old with a $500,000 policy would cost $571 per month. It is about 19 times more expensive than term life policy.
Many financial experts argue that whole life policies are unnecessary because most people do not need insurance for their entire lives. Once you stop working, your family may no longer depend on your income and may not need coverage if you die.
universal life
Like whole life insurance, a universal life policy will last your entire life. However, universal life may also come with a cash value that you can borrow from or withdraw from while you’re alive. You can also use the cash value to make your monthly premium payments, but this is usually only available after you’ve made several years’ worth of payments.
The cash value is invested in the stock market, but the amount earned is limited by the insurance company. Monthly premiums for universal life policies are the same as whole life premiums.
How to choose between annuity and life insurance
Before choosing between annuity and life insurance, you need to figure out what exactly you are looking for from these products. Is it money for your family if you pass away during your prime earning years? Is this a nest egg to use during your golden years?
It is important to determine your motivation in order to choose the most suitable product. If you’re looking to invest for retirement, a 401(k) or an Individual Retirement Account (IRA) may be a more appropriate fit than an annuity or life insurance.
Using insurance or annuities as an investment is rarely a good idea. Annuities and life insurance almost always have limits on how much you can earn in a year, which can constrain your nest egg.
“In most cases, you’ll be better off using investments for investment and insurance for protection,” said Jay Zigmont, financial planner at Childfree Wealth.
If you want to protect your family financially in the event of your death, a term life policy may be the best option because of the low premiums compared to a whole or universal policy, leaving you money to use for other things. Get more money, like investing.
As always, you should consult a financial professional when making these types of decisions.
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