What is the difference between life insurance and an annuity?
Life insurance and annuities are both financial products, but they serve different purposes and have distinct features. Here are four key differences between life insurance and annuities:
(1) Purpose and Beneficiaries
Life Insurance
The primary purpose of life insurance is to provide a death benefit to the beneficiaries (such as family members or dependents) of the policyholder in the event of the policyholder's death. Life insurance offers financial protection to the policyholder's loved ones, helping them cover expenses and maintain their standard of living after the policyholder's passing.
Annuities
Annuities, on the other hand, are designed to provide a steady stream of income to the annuitant (the person who owns the annuity) during their retirement years. Annuities offer a way to convert a lump sum of money into a guaranteed income stream, either for life or a specific period.
(2) Payment Structure
Life Insurance
Life insurance policies require regular premium payments by the policyholder to keep the policy active. If the policyholder passes away while the policy is in force, the beneficiaries receive the death benefit.
Annuities
Annuities can be purchased with a lump sum or through a series of payments. The annuity issuer (typically an insurance company) invests the funds and provides periodic payments to the annuitant, either immediately or at a later date (deferred annuity). Annuity payments can be fixed (guaranteed) or variable (linked to the performance of underlying investments).
(3) Risk and Return
Life Insurance
Life insurance provides a predetermined death benefit, and the premiums paid by the policyholder do not accumulate or earn interest. The benefit is paid out upon the policyholder's death.
Annuities
Annuities offer the potential for investment growth, especially in the case of variable annuities. The annuitant may receive payments that vary based on the performance of the underlying investments. However, there is a risk of loss, and some annuities come with guarantees to protect against market downturns.
(4) Tax Treatment
Life Insurance
Death benefits received by beneficiaries from a life insurance policy are generally tax-free. The cash value of a life insurance policy grows tax-deferred.
Annuities
Annuity earnings are tax-deferred until they are withdrawn. When annuity payments begin, a portion of each payment may be considered a tax-free return of principal, and the remaining portion is taxed as ordinary income.
It's important for individuals to carefully consider their financial goals and needs before purchasing either life insurance or annuities. Consulting with a financial advisor can help in making informed decisions based on individual circumstances.
This information is intended for information purposes only. Any reader understands that Apex Benefit Group is not providing legal advice, tax advice, or professional services in this article. This article serves to offer practical information regarding the subject matter and is not a comprehensive resource.
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Insurance is an essential part of financial planning, providing protection and peace of mind for individuals, families, and businesses. However, before purchasing insurance, it's important to have a clear understanding of its purpose, the different types available, underwriting guidelines, insurance providers, and policy inclusions and exclusions.