Annuities Vs. Life Insurance: What’s The Difference?

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Annuities and life insurance are both products offered by insurance companies, but they provide different types of benefits.

• An annuity is a contract that offers a stream of income for a set period of time, often during retirement, in exchange for money paid into the annuity.
• Life insurance is a contract that offers a cash payment to the contract’s beneficiaries if the policyholder dies while the policy is active and the terms of the contract are met.

Annuities provide a benefit when you’re alive, and life insurance provides a payout when you pass. But in some cases, annuities may offer features that look a lot like life insurance.

Here’s how annuities and life insurance work, and their similarities and differences.

How annuities work

An annuity offers a stream of income for a period of time, often for the life of the policyholder, helping to create income stability.

Annuities can ensure that you never outlive your income. Annuities will pay income for the time period specified in the contract. That could be a fixed period, such as 20 years, or the remainder of the policyholder’s life or even a spouse’s life, too.

Annuities are a financial product offered by insurance companies, and you may purchase an annuity with either a lump-sum payment or a series of payments over time. People often use annuities as part of their retirement strategy, which may include life insurance or traditional retirement accounts such as an IRA.

Annuities come in a variety of types, depending on their potential returns and when they’ll begin paying out.

What features do annuities offer?

Annuities can be structured to offer a broad range of features, depending on your needs. This customization makes annuities more complex and expensive though. These are some popular annuity riders.

• Minimum guaranteed payout: Some annuities guarantee that you’ll get a minimum payout over some period of time.
• Death benefit: The annuity may pay out the remainder of the account to heirs and may also offer an insurance-like payout on the holder’s death.
• Survivor’s benefits: Some annuities may allow the surviving spouse to receive the annuity’s cash flow.
• Other riders: Other features can be added to the annuity and may offer insurance-like benefits and payouts.

How life insurance works

Life insurance offers a cash payout to beneficiaries on the policyholder’s death if the terms have been met. In exchange, the policyholder pays a regular premium to the insurance company, typically on a monthly, quarterly or annual basis. There are two main types of life insurance.

How term life insurance works

Term life insurance provides coverage for a specific period of time and then expires. Premium payments for term life are typically fixed for the life of the contract, while the death benefit may be fixed with some policies or increase and even decrease with time.

A term life policy may require the policyholder to undergo a medical exam to qualify for coverage. Unlike permanent life policies, term life policies do not have a cash value account, meaning that a policyholder does not accrue any value in the account that can grow or be borrowed against.

Term life insurance may be a good fit for those who want coverage only for a specific period, such as parents of young children or those with a significant debt burden, such as a mortgage. Term life is generally cheaper than permanent life, giving many a cost-effective option for coverage.

How permanent life insurance works

Permanent life insurance provides coverage for the policyholder until death as long as the premium is being paid. Permanent life has two parts — a death benefit that offers a cash payout on the policyholder’s death and a cash value account that acts like a savings or investment account. A medical exam is usually required to purchase a policy.

There are different types of permanent life insurance. Here are a few.

• Whole life insurance: Whole life insurance offers a fixed premium and death benefit that doesn’t change.
• Universal life insurance: Universal life insurance offers flexible premiums and death benefits that you can adjust.
• Variable life insurance: Variable life insurance allows you to pick your investments from various subaccounts, usually stock and bond funds. How your investments perform can affect your cash value and death benefit.

The cash value account can be an attractive feature, allowing the holder to save and invest or even borrow from the policy. The potential for gain is higher with cash value that is invested in the stock market, though it comes with higher risk, too.

Permanent life insurance may be a good fit if you want coverage without an expiration date and access to the cash value. Permanent life is usually more expensive than term life.

Key differences between annuities and life insurance

While annuities and life insurance are both offered by insurance companies, they are distinct products designed to serve different needs.

• Purpose: The goals of an annuity and life insurance differ. An annuity safeguards your income, perhaps for life, whereas life insurance protects your heirs if you die.
• Payouts: While annuities provide income for you during your lifetime, life insurance offers a cash payout to heirs upon the policyholder’s death.
• Premiums: Annuities may be purchased in a lump sum or over time, while life insurance is paid over time in regular installments.
• Planning: Annuities are used in retirement planning, while life insurance is more about estate planning and preventing financial catastrophe.
• Death benefit: Annuities may offer a death benefit like insurance does, but their primary purpose is to deliver a stream of cash flow, not provide for heirs.
• Access to cash: Some annuities offer limited withdrawals once the contract begins while most permanent life insurance offers access to the cash value as a loan or withdrawal, too, within certain parameters.
• Medical exam: Medical exams may be required for life insurance, but are not required for annuities.

Bottom line

Annuities and life insurance offer different benefits to different people at different times. While annuities offer an income stream to holders while they’re alive, life insurance offers cash to beneficiaries of policyholders when they pass. It’s important to understand which kind of financial product works better for your needs and financial situation.

— Bob Haegele contributed to an update of this article.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.