If you're new to the world of investing and are deciding where to place your hard-earned money, you've probably come across terms like "life insurance" and "annuity." While both can play an important role in your financial plan, they're generally used for different purposes. But there are instances in which their differences are not as great as you might think.
Life insurance is a product designed to provide a death benefit to the policyholder's beneficiary, typically a spouse or partner, upon his death. Its purpose is to allow the beneficiary to maintain her same standard of living or pay off large expenses. An annuity is an investment product sold by life insurance companies. You pay the company a predetermined amount of money at regular intervals, and your money earns tax-deferred interest. When you reach the end of the annuity period, you begin to receive regular payments based on your age and the amount in the accumulated fund.
Your circumstances will dictate whether you need life insurance and in what amount. Generally, the more financial obligations you have, such as a mortgage and providing for a family, the more you will need life insurance to provide for your loved ones in the event of your death. An annuity can be used as part of a retirement program to supplement a pension or Social Security benefits. Because annuities earn tax-deferred interest, meaning you don't pay taxes on the interest until you withdraw the money, they can also be used to save on taxes.
Living and Death Benefits
While it can be said that life insurance provides a death benefit while annuities provide a living benefit, there can be areas where the two products are similar. Some forms of life insurance, like whole life, universal life and variable life, build cash value that can be used to supplement a retirement fund or cover emergencies. Annuity owners can set up the payment structure so that when they die, a beneficiary can take over the receipt of payments.
You can use an investment strategy that combines life insurance and annuities. While your family is young and your financial obligations are large, you can purchase life insurance to provide protection. As your obligations begin to decrease along with your need for life insurance, place the money you had been spending on insurance premiums into an annuity to save for retirement.