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What Is a Life Insurance Annuity?

A life insurance annuity is a way for beneficiaries of a life insurance policy to spread out payments from the death benefit instead of receiving a single lump sum.

With an annuity, you would receive a series of payments according to the contract you create with the policy’s life insurance company. For example, you could choose monthly, quarterly, or annual payments. This could make managing the payout money easier instead of trying to handle the entire payout all at once.

Life Insurance Annuities vs. Life Annuities: Similar, But Different

Life insurance annuities and life annuities sound the same, but there are key differences:

  • Life insurance annuity: This is technically a type of life annuity, but functions as a form of payment that beneficiaries of a life insurance policy can choose. It is an alternative to receiving a single lump-sum payment of the death benefit. When you, as a beneficiary, decide to participate in a life insurance annuity, you receive guaranteed incremental payments, which may feel more manageable than a large one-time payout. 
  • Life annuity: This is a stand-alone investment vehicle designed to supplement your retirement income. It is not related to being a beneficiary of a life insurance policy. Instead, it is a product you purchase on your own. You can deposit money into it once or at regular intervals to fund the life annuity. The balance earns interest at a variable or fixed rate, and you receive regular payouts from it for as long as you live. 

In short, as a beneficiary of a life insurance policy, you may choose to receive the payout in the form a life insurance annuity. This would then convert your payout into a life annuity product that you own, using the death benefit balance to fund it.

How Life Insurance Annuities Work

Fixed-period Annuity
Lifetime Annuity
Lump Sum
How long do payments last?
Set amount of time; payment term is set by the beneficiary
As long as the beneficiary lives
One time; the entire amount is bestowed at once
Converted to life annuity vehicle?
No; unless invested separately

The main difference between a lump-sum payout and a life insurance annuity is how many times you would receive payment. In a lump sum, you would receive the entire payout all at once. With a life insurance annuity, you would break the payments up into one of two types of annuities: a fixed-period annuity or lifetime annuity.

Fixed-period Annuity

With a fixed-period annuity, also called a period certain annuity, the beneficiary of the death benefit chooses how long to receive regular payments from the payout. The insurance company provides an annuity contract stating that the beneficiary can receive this income for the selected period of time. 

Lifetime Annuity

With a lifetime annuity, the insurance company provides money from the death benefit for the beneficiary’s entire life, no matter how long they live. This means even if the total death benefit amount is paid out because you have essentially outlived your annuity, you would still receive payment.

Conversion to a Life Annuity Product

After you decide to receive the death benefit as a life insurance annuity, your payout will convert into a life annuity product that you own. This means your payout would fund the life annuity, and as you receive payouts over time, the remaining balance would earn interest.

Benefits of This Conversion

Besides breaking up a large death benefit into more manageable payouts, turning your life insurance annuity into a life annuity product come with the following beneficial features:

  • You could have guaranteed income for life. Unlike other types of investments, such as stocks or bonds, a life annuity provides a steady and predictable source of income — and it is unique in that it continues to pay out over the entirety of your lifetime if you elect a lifetime annuity.
  • Your death benefit payout would have the potential for investment growth: All life insurance annuities earn tax-deferred interest over time, though life insurance annuities do so at a relatively slow rate.
  • Life insurance annuities can help with estate planning. If your life insurance annuity contract allows you to name a a beneficiary, that person will receive the remaining value of the annuity if you pass away before the annuity has been fully paid out. This can be a way to leave a financial legacy to your family.

To best understand whether a life insurance annuity fits in with your plans, learn more about life annuities in general to see if they are a good idea for your financial goals. Also keep in mind that there are many life annuity types available, but many insurers only offer life insurance annuities as fixed-rate life annuities.

Should You Get a Life Insurance Annuity?

While many people choose to receive a death benefit in a single payment, receiving a death benefit payout as an annuity could work for those where the following is true:

  • You find the lump-sum payment from a death benefit overwhelming. If you are unsure about your ability to manage a large amount of money all at once, a life insurance annuity can help you space out the funds into more manageable amounts over time.
  • You would like to spread the death benefit out as supplemental lifetime income. Life insurance annuities would structure the payout to last throughout your lifetime as supplemental income.
  • You do not need the money to cover immediate expenses. If you do not need to use the death benefit to take care of immediate end-of-life expenses like medical bills or funeral and burial costs, it may make sense to choose incremental payments instead of a lump sum. 
  • You are interested in converting the payout into a life annuity vehicle so it may earn interest and grow over time. Annuities earn interest, and choosing a life insurance annuity can help you diversify your investments, ultimately growing the payout amount over time.

However, before committing to receiving your payout as a life insurance annuity, be sure you understand the downsides too.

Drawbacks to Keep In Mind

Unlike lump-sum payouts, annuities can be complex. Keep the following in mind when deciding if life insurance annuities are the route you want to take:

  • It takes time to receive the full death benefit amount. Life insurance annuities pay only a small portion of the total death benefit amount. It could take decades for the beneficiary to receive the entire death benefit. 
  • You are limited to one type of life annuity if you get life insurance annuities. Many insurers will only offer life insurance annuities as fixed-rate annuities. If you are interested in a different life annuity type — such as qualified or variable — that option may not be available with a life insurance annuity.
  • There are taxes and fees with annuities. When your life insurance annuities convert to life annuities, you may have to pay fees and taxes. In contrast, a lump-sum payout to a beneficiary is tax-free.
  • As an investment, life insurance annuities provide a low rate of return. All life insurance annuities are converted into life annuities, but it may be more effective to take a lump-sum payout and invest that amount into a life annuity of your own choosing. This way, you can choose your own lender and product to help you earn interest at a potentially faster rate.

What This Means For You

Getting a life insurance annuity can help break a death benefit payout into more manageable portions distributed over time. Because it is converted into a life annuity product too, the amount could grow, helping you to earn more money on interest over time.

However, life insurance annuities come with fees and taxes. In contrast, a lump-sum payout is generally tax-free. For this reason, it is ultimately a better idea to receive a death benefit as a lump sum. But this lump sum could then be invested into your own life annuity vehicle if you would still like to benefit from a life annuity’s features, such as receiving supplemental income for the remainder of your lifetime.

Life insurance and annuities are both important financial tools that provide enough versatility to become an important part of an overall financial plan that includes a solid retirement strategy. Consult with a financial planner to best understand how life annuities and life insurance can work together to help build your investment portfolio.

Plan for your family’s future. Get a life insurance quote today.

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Plan for your family’s future. Get a life insurance quote today.

Get a quote