Annuities are designed to benefit you during your lifetime through periodic income. Life insurance is designed to take care of your loved ones after you die. Both provide the advantage of tax-deferred earnings. Each is meant for a different purpose, and each has its advantages and disadvantages for financial and estate planning.
Whole Life Basics
With a whole life policy, you typically pay a fixed premium to the insurer for the rest of your life. A portion of your premium pays for the insurance costs, while the rest is used to accumulate a cash fund over time. When you die, your beneficiary receives the face amount of the policy, which is the amount of insurance that was originally purchased, but not the accumulated cash.
Fixed Annuity Basics
A fixed annuity is a retirement investment product that is also sold by life insurance companies. You pay a fixed premium to the insurance company over the life of the contract, which grows at a fixed and guaranteed interest rate, or you can make an upfront lump-sum purchase. When the contract matures, you receive your original investment, plus interest, in fixed installments for a designated time period or for the rest of your life, depending on the payout option you select.
Whole life policies contain a loan provision that allows you to borrow money from the accumulated cash value at a relatively low interest rate, without the need for collateral. The money does not have to be repaid, but failing to do so reduces the face amount by the value of the outstanding balance plus interest upon your death. You can also surrender a whole life policy and receive the accumulated cash value, but you'll be taxed on any amount in excess of the premiums you've paid over time, in addition to losing your life insurance coverage. Because fixed annuities are designed to provide retirement income, premature withdrawals are discouraged. You'll typically incur a 10 percent penalty on top of the income taxes on withdrawals made before age 59 1/2. Fixed annuities generally do not include loan provisions.
With a whole life policy, your beneficiary receives the face amount of the policy no matter when you die. If you have a $100,000 policy but pass away after only three years and have paid only $3,000 in premiums, for instance, your beneficiary still receives the $100,000. On the other hand, if you own an annuity, your beneficiary will only receive the amount of your investment plus any accumulated interest upon your death.
While the cash value of whole life policies and earnings of annuities grow on a tax-deferred basis there is an important difference at the time of death. The proceeds of all forms of life insurance, including whole life, are paid on a tax-free basis to your beneficiary when you pass away. With a fixed annuity, the interest earned is considered as taxable income to your beneficiary.
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