Difference Between an Annuity and a Life Insurance Policy

by Gregory Hamel
Annuities are designed to provide recurring income during retirement.

Insurance can help pay for costs related to unexpected events like auto accidents and home fires, but insurance companies also sell products aimed at helping people plan for retirement. Annuities and life insurance plans are two types of financial products insurance companies offer that can be used to provide yourself cash during retirement.

Annuities

An annuity is a type of retirement plan you can open with an insurance company that provides you with monthly income payments during retirement. Annuities can be either immediate or deferred. With an immediate annuity, you pay the insurance company a lump sum of cash, and in exchange, you get income payments for the rest of your life. With a deferred annuity, you save cash that grows in investments for a number of years leading up to retirement and then you can start withdrawing cash or use it to buy an immediate annuity that gives you income payments for life.

Life Insurance Plans

A life insurance plan entitles your loved ones to a cash payout if you happen to die while your coverage is active. Life insurance comes in three basic forms: term life insurance, whole life insurance and universal life insurance. Term life insurance only lasts for a fixed period and does not include any savings component. Whole life and universal life can last your entire life, and they both include a savings component where a portion of the monthly fees you pay accumulate as cash you can tap into later in life. Universal life offers flexible monthly fees, while the rates on whole life plans generally don't change.

Similarities

Annuities are similar to whole life and universal life insurance plans in that they all allow you to set cash aside that you can access during retirement. In addition, all three types of plans offer the benefit of tax deferral on your savings. Tax deferral means you don't have to pay taxes on any earnings your savings generate over time, until you withdraw them. On the other hand, annuities and life insurance plans can also involve paying significant fees.

Differences

Annuities are designed specifically for retirement saving, so all the cash you put toward an annuity goes into producing retirement income. Life insurance plans with a savings component serve two purposes: to provide your loved ones with a cash death benefit if you pass away and to build a cash value while you are alive. Life insurance plans typically aren't a good way to save for retirement, however, because a substantial portion of the cash you put in pays for the death benefit and does not go toward building up the plan's cash value.

About the Author

Gregory Hamel has been a writer since September 2008 and has also authored three novels. He has a Bachelor of Arts in economics from St. Olaf College. Hamel maintains a blog focused on massive open online courses and computer programming.

Photo Credits

  • Comstock/Comstock/Getty Images