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What is a life insurance annuity?

As a beneficiary, you can opt to get the policy payout in increments — which are known as annuities.

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When a policyholder passes away, their loved ones receive a payout known as a death benefit. The beneficiaries can choose how they want the payment to be dispersed. They can get a lump sum or have it split up into increments — or annuities. These annuities offer a source of income for a set period of time, but they can be complex.

What is a life insurance annuity?

A life insurance annuity pays out your policy to your beneficiaries in increments rather than a lump sum. It’s designed to provide your loved ones with a steady stream of income when you’re gone.

Your beneficiaries are guaranteed to get a specific amount of money monthly, quarterly or biannually until the annuity expires. The amount is made up of your payment, plus interest — and that interest accrues at different rates depending on the type of annuity you have.

How do life insurance annuities work?

If you want the proceeds of your life insurance policy to be paid out in annuities, these are the options:

  • Fixed annuities earn interest at a fixed rate set at the time you buy the annuity.
  • Variable annuities are tied to market conditions, so the rate may fluctuate over the life of the annuity.

The different payment structures

You can then choose a payment structure:

  • Fixed-period annuities pay out over the course of a certain number of years — like 10, 15 or 20.
  • Lifetime annuities pay out over your entire life. The payments will typically be in smaller amounts because they’re stretched over a longer period of time.

Who should consider a life insurance annuity?

As a beneficiary, you might opt to receive your payout in annuities if:

  • You prefer a set budget. A guaranteed payment over a set number of years or your lifetime can help if you’re looking to keep your spending in check, especially if you receive a large sum of money at once.
  • You’re looking for a low-risk retirement supplement. Even a well-planned retirement may require extra income. Since annuities are highly customizable contracts, you can access those extra payments without taking on too much risk.
  • You don’t have a lot of expenses. If you’re retired or have fewer obligations than you did in previous years, an annuity could keep you financially comfortable.

What happens to a life insurance annuity if the owner dies?

It’s important to understand how your annuity is structured in case of your death. Work with the insurance company you’re considering to find out your options and choose what’s best for your loved ones.

  • If you die before the income payment period.
    If you pass away at an early age your money may go to the annuity provider. It’s also possible that any money contributed to the point of your passing goes to your beneficiaries. You can have a minimum payment term as part of the annuity contract that allows your spouse or dependents to receive payments for the rest of the term outlined in the contract. They may also be paid in a lump sum.
  • Reversionary annuity.
    If you’re willing to pay much more for your contract, you can guarantee a lump-sum payout to your beneficiaries. Depending on your situation, life insurance may be a more cost-effective option.
  • Guaranteed period option.
    A guaranteed period option in the contract of an annuity will allow your beneficiary to receive the remaining income payments as an income stream or a lump sum.

Annuity vs. lump sum

A lump-sum payment is a single payout, as opposed to an annuity that pays out slowly over time.

Life Insurance Annuity

Pros
  • Guarantees income for a set amount of time
  • Pay any taxes slowly as you’re paid out
  • Possible to continue paying beneficiaries if you pass away
Cons
  • Typically doesn’t gain a significant amount of interest
  • Limited access to the funds
  • Steep penalties for early withdrawals

Lump Sum

Pros
  • Access to the entire amount to fund large purchases
  • Potential to invest in a high-return account
  • Can leave any amount not spent to beneficiaries
Cons
  • Any taxes will likely be due on the full amount
  • Potential to spend it too quickly
  • Weight of responsibility is on you to manage funds

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How is a life insurance annuity different from life insurance?

Life insurance and annuities share some similar features, but they each play different roles in financial planning. Annuities are contracts and designed to be paid out while you’re still alive, and life insurance provides money to your loved ones when you die.

Here are a few major differences between annuities vs life insurance:

Life insurance annuityLife insurance
Is there a death benefit?The death benefit of the life insurance policy will be paid out in installments, rather than a lump sumYes — equal to the coverage amount or face value of your policy
Can it be built up as savings?YesPermanent policies have a savings component, but term policies don’t
Are there tax benefits?Taxed as income upon payoutYes — the death benefit is paid out tax-free, unless your property is subject to estate taxes

How can I buy a life insurance annuity?

Many major life insurance companies can pay death benefits in installments. When you’re comparing insurers, ask about the various payment options. And if they do offer annuities, how the payments can be structured.

How much do life insurance annuities cost?

Annuity costs can be difficult to determine because the level of annual income you receive is based on investment costs, risk, profit for the annuity provider and the various administrative and marketing costs.

Providers will promise a certain return on your money, and this promise of return is calculated after taking costs into account. This means you won’t generally be paying for annuity costs right out of your income payments.

You’ll be paid the promised return on your money regardless of whether the provider makes more or less than what they promise to you. Different providers will offer up annuities with different cost structures.

Bottom line

A life insurance annuity is a contract that pays out a policy in increments — which can be helpful for beneficiaries who need to restrain their spending or are looking to supplement their retirement income.

When you’re purchasing a policy, be sure to compare life insurance companies to get the best possible deal.

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