Annuity vs. Life Insurance

With over four decades of financial services experience, Larry Anders has been the CEO and chairman of Summit Alliance Financial, LLP, a Dallas-based independent brokerage general agency, since 1997. Emphasizing professionalism and comprehensive support, Larry Anders and his team help clients navigate the various insurance products, including annuities and life insurance.

Both annuities and life insurance allow policyholders to plan for their financial future and make tax-deferred investments. This means their investment gains accumulate tax-free until they actually start withdrawing funds. However, annuities and life insurance fundamentally differ in purpose, payments, benefits, and taxation.

The main goal of an annuity is to serve as a safety net for policyholders and prevent them from prematurely exhausting their savings by providing them with a guaranteed income for life or a specified period. The annuity owner or annuitant pays insurance companies an upfront lump sum or installments over a specific period of time, which grants them regular income payments at a set future date. Annuitants do not have to pay taxes on the upfront payments, but once they start withdrawing funds, a portion of these payments will be taxed as ordinary income.

Meanwhile, the primary purpose of life insurance is to protect a policyholder’s family from potential financial difficulties in case they die. Life insurance holders pay regular monthly or annual premiums, which entitle their beneficiaries to a death benefit upon their passing. Some types of life insurance also offer a cash-value option on top of the fixed death benefit, allowing policyholders to gain interest on a portion of the premiums and accumulate tax-deferred funds, which they can withdraw while still alive. Generally speaking, life insurance death benefits are not taxed as ordinary income, to the beneficiaries.

However, in some instances, like employer-paid life insurance, if the coverage exceeds the maximum non-taxable amount allowed by the Internal Revenue Service, the employee will have to pay income tax on the excess premiums. Also, once a policyholder decides to surrender the accrued cash value accumulated in the policy, they will be taxed on the difference between the cash-value amount and the total amount of premiums paid throughout the policy term and this excess will be taxed as ordinary income.