Choosing between life insurance and annuities can be a complicated task as there are many options of both life insurance and annuities available.
Both options can be as stripped down to basics or customized with all sorts of bells and whistles but if you’re thinking about getting started in either product it’s best to have some general understanding of each item and then consult an insurance professional.
Let’s start with understanding insurance in general. Any financial planner would and should tell you that insurance is the foundation to a successful financial plan/strategy.
Outside of insurance, your financial planner can put together amazing profit projections, rates of return to the moon, tax advantaged plans to leverage your cash flow and a myriad of other proposals to meet your financial goals down the road based on your budget and current lifestyle. But unless you are properly insured/protected all of those attractive numbers irrelevant.
Here’s why; think of all your assets and income as pieces of your financial castle. This is your savings, retirements, stocks, bonds, real estate, investments and even your ability to work. These are all building blocks for your financial castle. Someday that castle will be enormous but it’s going to take time, it’s going to take materials and it assumes that both of those resources will be in steady supply. Your investment strategy assumes that you will be alive and healthy to supply the money and time it takes to create your castle.
So how do you protect your castle and ensure it will be built?
Most castles had a moat surrounding the entire castle.
Life insurance is part of that moat. It’s not the entire moat but it’s a significant portion. We are guaranteed to die at some point in our life. It could happen today or in the future. Most of us will make it to old age before we die but what if it happens sooner than we expected? All of a sudden we are not alive to make the money to fund our financial castle or to take care of those who depend on us.
Why life insurance? Well, the purpose of life insurance was to provide financial protection to those who depended on the life being insured. For example, a single income family of five loses the sole provider to some accident or illness. The emotional loss is priceless, the financial loss can be calculated though.
Let’s say that sole provider was housing and supporting the spouse and three children on a $100k annual income and the monthly cost to support everything was only $5k/mo. This means that house, cars, necessities were supported and there was money left over. Well 12 months times $5k is $60k so they had $40k they were putting away right? Nope, don’t forget taxes, let’s say after write-offs it’s only $70k net.
All of a sudden, because of death, there is $0 coming in monthly and $5k going out. Their financial plan started 10 years ago and let’s say they saved on average $5k/year with some return, they have $70k saved up after 10 years and some equity.
Well, in less than year that savings is gone if you factor in a standard cremation fee of $10k give or take, 10% of early withdrawal taxes on investments and of course the monthly $5k going to support house and kids.
-$ 7k 10% early out tax
-$10k final expenses
$53k left over divided by $5k/mo = 10.6 months
This doesn’t account for the loss of company paid benefits like health insurance or consider that the surviving spouse may need to incur day care expense when they look to return to the workforce and of course, the family is just looking to survive at this point, there is NO MONEY to invest during this time. That $70k castle didn’t last for a year but took 10 years to build.
So that’s why you buy life insurance! Protect your assets such as your family. But then the question is how much?
1. A great approach is to find out first if you qualify. If you don’t qualify you can’t buy protection. The best time to get qualified is when you are young and healthy! The younger and healthier you are the less expensive this valuable coverage will cost.
2.Once you have found that you have qualified, work with your insurance professional to draft proposals around your budget-protection is no good if you can’t afford it right?
3. Know the basic options of life insurance products-there are several.
Here are some of the most common:
-Term life Insurance – this is the most basic and often the cheapest option. You buy coverage for a term of 10, 20 or sometimes 30 years for a set monthly/annual premium. It only pays out when you die within that specific term. Many choose this option because it’s cost effective and saves them money. The downside is that it’s an unrecoverable cost if you don’t die.
-Whole Life Insurance -usually has premiums that remain fixed for the life of the policy. Whole life insurance also builds a savings element since part of the premium is used to accumulate a guaranteed cash value. Dividends, which are not guaranteed, may also increase policy cash value.
-Variable Whole Life Insurance -a form of permanent life insurance under which the death benefit and the cash value of the policy fluctuate according to the investment performance of the variable investment options selected by the policy owner. With variable life insurance, you get to decide where to invest your money among the multiple investment accounts. Many variable life insurance policies guarantee that the death benefit will not fall below a specified minimum if the required premiums are paid, but a minimum cash value is not usually guaranteed.
-Universal Life Insurance – a variation of permanent life insurance that offers flexible premiums and the choice of either a level or increasing death benefit. As in Whole Life, cash value builds within the policy. While there are guarantees built into the policy, the cash value is based on the performance of the company and on how much premium is paid.
-Variable Universal Life Insurance – a form of variable life insurance that combines the premium and death benefit flexibility of universal life insurance with the investment flexibility and risk of variable life insurance. It is important to note that in both variable whole life and variable universal life, the insured bears the investment risk within the policy.
All of these products can be customized with riders and options to fit individual needs if you sit down with an insurance professional. Examples would be the option to convert a term policy to a permanent, or options to purchase more insurance down the road etc.
So what about annuities? Annuities were designed to address the very real concern of outliving the money saved for retirement. People are living longer and healthier lives in retirement but those prime earning years are gone and monthly income with it.
Sure, the kids are gone, the house is paid and maybe you’re debt free but, you still pay taxes, you still drive, you still see your doctors and you still need to eat. All of these have risen in price over the years due to inflation and other factors not considered earlier up the road.
So how long would your nest egg last assuming everything stays stable and you don’t incur any intended/unintended major expenses like long term care costs? 1 year, 10 years 15 years? Who knows. You have some money to last you for a fixed period and there is a very real possibility that you can outlive it.
Enter annuities! These vehicles have various rates of return but provide the peace of mind that should your savings/investments run out, the insurance company will continue to pay a stream of income as long as you live. You can even have them structured to have that income paid to your surviving spouse/beneficiary.
There are several options to fund an annuity from monthly payments for the early-birds and then there are single pay-immediate pay out annuities that can be funded in a lump sum deposit like a rollover!
There are multiple versions of annuities as well:
-Fixed Annuity is a contract where principal, interest, and the amount of benefits paid are fully guaranteed by the insurance company.
-Variable Annuity – does not offer guaranteed returns. Instead, variable annuities offer the potential to realize higher rates of return by giving you the opportunity to choose the variable investment options in which your money will be invested. Please keep in mind that your rate of return is not guaranteed and your principal is subject to fluctuations. Many variable annuities also offer a fixed interest rate account in addition to the variable investment options.
-Immediate Annuity – purchased with a single premium payment and you set the starting date for the payout to begin sometime within the next 12 months-generally sooner rather than later.
-Deferred Annuity – an annuity for which annuity payments to the owner begin only after a period of time, known as the accumulation period, has passed. During the accumulation phase, you can attempt to build your deferred annuity with a lump sum, a series of payments over time, or both. The ability to combine one-time and periodic contributions gives you added flexibility as you seek to build a larger retirement resource.
So, now you have a very basic knowledge of both Life Insurance and Annuities and why they should be considered. You know what is needed to protect your castle and how you can assure you have the resources to live in that castle when it’s completed.
However everyone’s goals, situations and budgets vary and you’ll have questions not remotely covered in this article. This is why, if you’re considering making a decision to move forward with life insurance or annuities, it’s wise to consult an insurance professional to help you with specifics.
How do you choose the right professional?
Like any product or service-comparison shop. There are many different insurance companies and agents, some agents work for only one company while others can comparison shop the various companies. Both have pros and cons. The one company agent may have exclusive access to specialty products that no other agent can offer but cannot shop the many different companies that an insurance broker can access for which could be more competitive and a better fit.
Your professional will be working with you for a long time as an adviser so use your gut to determine who you choose to do business with-do they seem genuine and sincere in taking care of you or are they just there for deal? If they are spending time with you, driving to meet you and showing you several options and answering your questions versus showing up and just filling an application and leaving in 20 minutes with your check, than you are working with a thorough professional instead of a salesman out to make commission.
Final thoughts, if your considering either life insurance or annuities or both, you should get started right away. Life insurance costs more as you get older and you lose the opportunity to gain interest on your annuity the longer you delay!