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If you’re looking to secure the financial future of your family, you may be considering 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 leave you with some practical advice to help you choose the right option for your specific situation.
What is an Annuity?
An annuity is a type of contract between a policyholder and an insurance company. There are several types of annuities, but all of them seek to provide monthly income while the annuity owner is still alive. The cost of the annuity depends on the type and the provider.
One downside to annuities is that they often charge fees, which can significantly drive up the cost. They can also be hard to get rid of, and you may have to pay a high surrender fee if you want to dissolve the annuity.
Customers often purchase annuities because they want the security of a guaranteed payout. Traditional stock market investing does not provide any kind of guarantee, which can seem risky to consumers.
Unlike life insurance, an annuity only pays out while the owner is still alive. If you die, the annuity will end. Consumers who are worried about outliving their retirement savings may purchase an annuity that will have guaranteed payments.
“If you expect your costs to remain stable and don’t want to worry about the ups and downs of stocks, annuities can give you peace of mind,” said Noah Damsky, CFA of Marina Wealth Advisors.
What is Life Insurance?
A life insurance policy will provide a death benefit to your heirs if you pass away while the policy is active. If there are people in your life who rely on your income, then life insurance can help them survive financially after you’re gone. Most people buy life insurance if they have a spouse or child who needs their income.
Some employers provide 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 crucial to choosing the best fit for you and your family.
Term life insurance
Term life insurance is granted for a specific period of time, usually ranging from 10 to 30 years. During that term, you will make equal monthly payments to the insurance company. If you pass away 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 will 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. Your beneficiaries will be eligible for a payout as long as you keep making the monthly premiums.
Because whole life policies are supposed to last your entire life, premiums are much more expensive than term life. According to PolicyGenius, a whole life policy for a 35-year-old man with a $500,000 policy would cost $571 a month. That’s about 19 times more expensive than a term life policy.
Many financial experts argue that whole life policies are unnecessary because most people do not need insurance to last their entire life. Once you stop working, your family may no longer rely on your income and may not need coverage if you pass away.
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 or draw from while you’re alive. You can also use the cash value to make your monthly premium payments, but this is generally only available once you’ve made several year’s 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 similar to whole life premiums.
How to Choose Between an Annuity and Life Insurance
Before picking between an annuity and life insurance, you need to figure out what you’re actually looking for from these products. Is it money for your family in case you pass away during your prime earning years? Is it a nest egg to use during your golden years?
Determining your motivation is key to choosing the most appropriate product. If you want to invest for retirement, a 401(k) or an Individual Retirement Account (IRA) may be more appropriate than an annuity or life insurance.
Using insurance or annuities as investments is rarely a good idea. Annuities and life insurance almost always have limits on how much you can earn in a single year, which can hamper your nest egg.
“In most cases, you would be better off using investments for investing and insurance for insurance,” said financial planner Jay Zigmont of Childfree Wealth.
If you want to protect your family financially in case you die, a term life policy may be the best option due to lower premiums than a whole or universal policy, leaving you more money to use for other things, such as investing.
As always, you should consult a financial professional when making these types of decisions.
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Zina Kumok is a freelance writer specializing in personal finance. A former reporter, she has covered murder trials, the Final Four and everything in between. She has been featured in Lifehacker, DailyWorth and Time. Read about how she paid off $28,000 worth of student loans in three years at Conscious Coins. More from Zina Kumok
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