The decision to purchase a life insurance policy or to buy annuities depends greatly upon your needs. Although both products are offered by insurance companies the two products are incredibly different. They actually function in nearly exactly opposite ways.
A term life insurance policy is intended to pay a lump sum at the time of death to the beneficiaries of the insurance policy holder. This policy can be paid for in a lump sum but is usually paid in the form of a premium.
The premium is most often paid monthly, but can be paid quarterly, semi-annually, or annually.
The insurance company makes money by investing the premium amount and by a process known as risk pooling: In any given year there will be enough people paying in to cover the claims of those that pass away.
An annuity works in exactly the opposite manner.
The purpose of an annuity is to provide income while living, for the rest of the policy owner’s life, no matter how long that person may live. It is true that annuities can in many cases continue to pay beneficiaries, but the primary purpose is guaranteed lifetime income.
This is opposite to how life insurance works. While life insurance takes a monthly premium and pays a lump sum at death an annuity takes a lump sum amount and pays an annuity payment until death.
The insurance company makes money by investing that initial lump sum and from people passing away before having received all of their money back- in some cases the insurance company simply keeps any remaining funds.
So, when choosing among a term life insurance policy and to buy annuities the risk/reward scenario to keep in mind is this:
A life insurance policy purchased is just in case you die.
An annuity contract is purchased in case you live.
An insurance company handles both products. The specific premium cost or payout amount is determined through a longevity table and is set at the time of purchase.
Another reason for choosing between life insurance and annuities is as an investment. Both products can be used as investment vehicles.
Life insurance can be purchase as whole life or universal life. Both of these have an associated cash value that is invested. The investment options vary according to the insurance company. An annuity can also work as an investment, either fixed or variable.
A fixed annuity functions like a bank CD, only with several additional benefits including tax deferral and ways to access your money in the event of need. These are longer term investments. A variable annuity is invested into an index fund. A fixed annuity will present no risk of principle loss in most cases, with the exception of insolvency of the insurance company. With a variable there is a risk of loss, but the potential for greater gain.
A whole life policy will make saving easy, by using a potion of your premium to invest. The investment itself is not guaranteed in any way. An annuity typically uses a lump sum, partial investments are not an option. A fixed annuity will provide a great deal of safety at the expenses of some potential gains. A variable annuity will invest in funds in a lump sum and provide certain safety nets.
When making the choice between life insurance and annuities consider your objective and how much risk you are willing to take. Depending on these factors either product may be best suited for your needs.