Life Insurance vs. Annuity: Pros, Cons & Payouts


The two reasons life insurance companies have been around since 1706 (Amicable Society for a Perpetual Assurance Office, London, England) is because people essentially still have the same two financial fears as they did over 300 years ago: dying too soon and living too long.

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Insurance companies developed two effective financial products in response to these fears: life insurance and annuities. Life insurance protects an insured person’s family if they die prematurely, and annuities provide a lifetime income to guarantee the annuity buyer never outlives their money.

Let’s look at both of these products in-depth and see how they stack up.

Overview: Life Insurance vs. Annuity

Just about everyone can tell you how a life insurance contract works: you give your money to the insurance company every month, and they pay a death benefit to your beneficiaries when you die. Simple enough.

Some people can tell you how an annuity contract works, too: you give your money to the insurance company, and they pay you a monthly income no matter how long you live. 

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Similarities and differences 

The similarities between a life insurance contract and an annuity are pretty obvious: you’re giving money to an insurance company, and they’re giving it back (plus or minus a few dollars). The big difference between the two is when, exactly, they give the money back.

With an annuity, they give the money back to you while you’re living. In return for giving the insurance company the use of your money, they’ll pay you interest and give it back to you in monthly increments until you die. If you want to name a beneficiary to get payments after you die, you can do that, too.

With a life insurance policy, you get your money back when you die. (Well, not you, but someone you designate as your beneficiary.) This money is intended to replace your income, pay off a mortgage, pay for your kid’s college education, or a variety of other reasons your family would need money if you were gone.

Annuities are sometimes called “life insurance in reverse” because of how annuities benefit the owner while they’re alive, and life insurance benefits the owner’s beneficiaries when they die.

Term life and whole life insurance vs. annuity

There are two primary types of life insurance: term life insurance and whole life insurance. Let’s see if there are any specific similarities between them and annuities.

Term life insurance is pure insurance; it has no living benefit for anyone. You buy the life insurance for a set term of years because you don’t intend to keep it your entire life, which is why it’s called term insurance. 

Term insurance bears no similarity to an annuity other than the fact that they both have named beneficiaries to receive a payout after the insured or annuitant dies, but this is optional with an annuity.

Whole life insurance has two components: life insurance and a cash savings feature (cash value). A portion of every payment you make for a whole life policy goes into the cash value, which builds over time and is credited interest by the insurance company. This aspect of whole life is similar to an annuity as the money in an annuity is credited interest by the insurer.

Whole life is also similar to an annuity in that the owner of either one can withdraw money while they’re alive. With a whole life insurance policy, the owner can withdraw or borrow money from the cash value in the policy. An annuity owner can structure their annuity to pay out a fixed sum every month for an agreed-upon period of time.

The third similarity between whole life insurance and an annuity is that the money in both financial instruments grows tax-deferred, and only a portion of it is taxed when withdrawn. This tax-deferred growth, over time, can mean the difference in there being thousands more dollars available at the time of payout as a living benefit for the insured and annuitant.

Life Insurance vs. Annuity: Payouts or Payment Schedule

Let’s look at how both life insurance policies and annuities pay out cash benefits and how/if they’re scheduled.

Life insurance payouts

A life insurance policy pays out a death benefit to a named beneficiary when the insured dies. It is usually paid out as a lump sum and is tax-free, though some beneficiaries prefer to receive the payout monthly or annually instead of receiving it all at once.

Annuity payouts

Annuities pay out several ways: either immediate or deferred. With an immediate annuity, payments are made to the annuitant one period after you buy the annuity, and payments end when you die. A deferred annuity allows your money to accumulate in a tax-deferred product and can be withdrawn when you’re ready, either as a lump sum or in regular payments.

» MORE: Your family has 500 hours of work to do after you die. Learn how to make it easier.

Life Insurance vs. Annuity: Charges and Costs

The cost of a life insurance policy and an annuity can be as different as night and day, but they can also be similar in some ways. Let’s look at the similarities first, then the differences.

Similarities in charges and costs 

Life insurance policies and annuities are similar in charges and fees assessed when the policy is purchased and when each payment is made afterward. Standard charges include commissions and administrative fees charged by the insurance company. 

Differences in charges and costs

The majority of annuities are purchased with a lump sum of money. The purchase price is not dependent upon anything other than the amount that the annuity owner wants to deposit. This differs from life insurance in that an insurance policy owner makes premium payments rather than depositing a larger amount at purchase.

Additionally, the cost of an insurance policy is based on the insured person’s age, health, and other factors. The cost of an annuity is not based on these factors. 

Life Insurance vs. Annuity: Who Are They For?

Since these two products accomplish different things, there isn’t a lot of similarity between the buyers. Here are the differences in who these products are best suited for.

Annuity buyers want to benefit while they’re alive

Someone who buys life insurance is primarily motivated by their desire to financially care for their loved ones when they die. True, some people buy a whole life insurance policy because its cash value grows tax-deferred, but it’s rare for someone to buy a whole life policy for that reason alone. 

Someone who buys an annuity primarily wants to invest in an account that will continue paying them an income for the rest of their life. They want to be able to experience the benefits of their purchase first-hand, rather than just leaving a benefit to their loved ones.

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Annuity buyers are often older

Life insurance buyers primarily want to provide income replacement, which is why most buyers are younger than annuity buyers. Life insurance buyers want their survivors to have enough money for sufficient cash flow, paying off debt, sending kids through college, paying final expenses (for whoever is responsible for funeral costs), and many other reasons.

Annuity buyers are typically older than life insurance buyers because they’re at the stage of life where they are concerned about having a consistent amount of monthly income and not outliving it. 

Many annuity buyers also own life insurance, which they bought when they were younger, during the accumulation phase of their life, whereas now, when they buy an annuity, they are in the conservation phase of their life.

Pros and Cons of Life Insurance and Annuities 

Both products have their advantages and disadvantages, so let’s look at each individually.

Life insurance pros and cons

Since term life insurance is temporary insurance, let’s focus on the advantages and disadvantages of whole life insurance. 

One advantage of whole life insurance is that the monthly premiums never increase, no matter how long you keep the policy in force. This is very advantageous for budgeting purposes, and the premium payment has less of a financial impact on your budget as your income grows.

Another advantage of whole life insurance discussed earlier is that the policy's cash value component grows tax-deferred, and the death benefit paid to the beneficiaries is tax-free. Wealthy individuals who put the maximum amount allowable into their retirement plans sometimes buy whole life insurance policies for the tax benefits.

The disadvantage of whole life is that only a small amount of interest is applied to the policy's cash value each month. 

Annuity pros and cons 

The main advantage of an annuity is that the owner can’t outlive the income that the annuity provides. Also, the growth of the annuity accumulates tax-deferred and is only partially taxed if payments continue to a beneficiary after the owner dies.

The biggest drawback to annuities is, similar to whole life insurance, the interest rate credited by the insurer is small compared to the returns that investors can realize in the stock market or through other investments. 

However, stock market gains are only a possibility (as are stock market losses). An annuity has a guaranteed interested rate; there can be no losses unless it’s a variable annuity

You Win Either Way

Though life insurance and annuities are intended for two different types of buyers, they’re both mart purchases, if they’re obtained from a financially secure insurance company. Shop around, compare rates and commissions, and think long-term. These are two products you’ll want to have around for a long time after you buy them.


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