What Is a Life Insurance Annuity? A life insurance annuity disburses the death benefit of a policy in a sequence of payments, extending over a significant period or until the beneficiary passes away. Additionally, if you choose a life insurance annuity over a lump sum, an unsettled portion of the death benefit will increase interest.
Although life insurance payouts are not taxable, you will pay taxes based on the interest gained on life insurance annuity payments. However, it’s important to note that not all insurers provide life insurance annuities. For beneficiaries, it’s advisable to inquire about the available payout options from the insurer when submitting a life insurance claim.
How Does it Work?
Generally, a life insurance annuity is different from a life annuity investment product. A life insurance annuity changes a beneficiary’s payout into a life annuity format. This change allows for disbursement over time, while the remaining death benefit continues to gain interest. After conversion, the provider disburses the additional benefit as requested in terms of the beneficiary over a specified period until the death of the beneficiary.
Additionally, choosing an extended timeframe for the life insurance annuity could lead to a greater overall payout. Beneficiaries are not required to make payments to the insurer if they choose the life insurance annuity payout method. However, any interest gained during the annuity period may be subject to income tax. It is advisable to reach out to a tax professional to comprehend the tax implications specific to your situation.
Is an Annuity a Type of Life Insurance Policy?
Annuities and life insurance policies are financial products with different functions. An annuity is a financial product that provides regular payouts to an individual. Typically, a huge sum of money is disbursed in installments over a specified period.
Additionally, individuals often invest in annuities gradually to ensure a steady income stream in their later years. Furthermore, most annuities allow for funding with a lump sum instead of periodic contributions. Although it is common for individuals to select annuity payouts for their life insurance death benefits, annuities extend beyond life insurance. Lastly, numerous people also select inheritance or retirement funds to be distributed through annuities.
Difference Between Life Insurance Annuity and Life Annuity
Life insurance annuities and life annuities are the same in terms of transforming a lump sum of money into a regular income. However, there are significant differences that exist between them.
A life annuity serves as a financial product aimed at ensuring a steady income. It’s commonly utilized as a retirement planning approach if you’re concerned about a financial crisis.
Meanwhile, a life insurance annuity has no direct payment to the insurance company. In addition, choosing a life insurance annuity simply changes a death benefit into a life annuity format.
Types of Life Insurance Annuities
There are two basic types of life insurance annuities, categorized by the duration for which the beneficiary offers to obtain annuity payments:
Fixed-Period Annuities
Fixed-period annuities are also referred to as specific-income or period-certain annuities. It has a fixed duration, typically ranging from 10, 15, or 20 years. Moreover, if the annuitant, who obtains the annuity payouts, passes away before the specified period concludes, the remaining payments will be directed to the beneficiary.
Lifetime Annuities
Lifetime annuities are also recognized as life income annuities. This ensures that the beneficiary of the life insurance policy, who changes into the annuitant, receives payments for the entirety of their life.
Moreover, to reduce the risk of premature death and potential loss of funds within the annuity, individuals choosing lifetime annuities often add an assured period. Additionally, if the annuitant passes away during the assured period, payments persist and are directed to a beneficiary of their choosing.
Should Life Insurance Beneficiaries Select the Annuity Option?
Life insurance annuities are not accessible in all circumstances, so when claiming a death benefit, inquire about the available payout alternatives. In addition, obtaining a lump sum could facilitate the coverage of funeral expenses, estate-related costs, or other significant financial obligations that may arise.
Furthermore, a lump sum disbursement could gain interest on the benefit of the investment, enabling creative options compared to an annuity payout.
However, if you are not ready to invest and manage a significant disbursement, obtaining payments through an annuity can offer a simple budget while gaining interest at a fixed rate. Moreover, you can contact a tax or financial advisor to assist in making an informed decision.
Advantages and Disadvantages of Life Insurance Annuities
An annuity can serve as a beneficial tool for individuals grappling with how to effectively manage a substantial sum of money. However, similar to most financial instruments, there are both advantages and disadvantages associated with annuities.
Advantages
There are various reasons why an individual should consider securing a life insurance annuity.
Easier to Manage a Large Sum of Money
If you obtain a significant lump sum of money all at once, it can be overwhelming to manage. An annuity provides the option to receive the funds gradually over time. In addition, it also aligns with your specific financial requirements and allows you to manage a large sum at once.
Consistent Income
Through an annuity, you can establish regular payments for a fixed duration or for the entirety of your life.
Financial support for loved ones
The majority of annuities offer this option to a beneficiary who will receive the remaining funds after you pass away. This ensures that if you are unable to utilize the funds during your lifetime, they can be passed on to a loved one.
Annuities are tax-deferred
Individuals are not to pay taxes on the funds held within the annuity. However, it will only occur when you make withdrawals, akin to a 401(k) or traditional IRA.
Disadvantages
Moreover, there are certain risks if you intend to secure a life insurance annuity instead of a lump-sum death benefit.
Long Timeframe
If you choose an annuity that disburses $60,000 annually from a $1 million death benefit, it would take nearly 17 years to receive the complete payout.
Early Withdrawal Fees
Compared to traditional investments that allow withdrawals from the main amount, withdrawing additional funds from an annuity beyond the annual payout typically leads to high early withdrawal fees.
Bad Investment
Due to its typically low rate of return, many individuals may find that investing some or all of a lump-sum payout independently results in greater value than choosing an annuity.
Tax Payment and Extra Fees
Interest earned on annuities is meant as a tax payment. Additionally, numerous annuities include additional fees and commission costs not present in other investment accounts, diminishing potential returns.
Conclusions
A life insurance annuity is only accessible to life insurance beneficiaries who receive the death benefit. In addition, life annuities represent various financial products that gain interest at either a fixed or variable rate and disburse payments over your lifetime.