What Is a Life Insurance Annuity?

Annuities and life insurance are two different products. However, a life insurance annuity policy offers a benefit payout over a set period of time. This makes them an ideal option for many people seeking a way to guarantee a consistent income for a chosen beneficiary after they've passed away.

If you're unsure of whether a life insurance annuity is the right choice for you, a local independent insurance agent can help you decide. They can help you weigh the pros and cons of a life insurance annuity to make an informed choice. But first, here's a closer look at life insurance annuities and when you might want to buy one.

What Is a Life Insurance Annuity?

A life insurance annuity is essentially using a life insurance policy's death benefit in a way that acts like an annuity. You may be asking, "How does a life insurance annuity work?" The policyholder can choose to have their death benefit paid out to a beneficiary in a series of regular, fixed payments over a predetermined period of time. This option works a lot better for many people than receiving a death benefit in one lump sum. 

What's the Difference Between an Annuity and Life Insurance?

Annuities and life insurance are very different types of products. Life insurance is a type of insurance policy designed to provide a financial payout, often in one large lump sum, to the beneficiary of your choice once you pass away. Often, a beneficiary is a spouse, dependent, or another family member. These policies help ensure a stable financial future for your loved ones after you're gone.

Annuities, in contrast, are financial products that can act as investments for your future. An annuity accumulates funds over time that can be later used to fund a regular income stream in retirement. When you're weighing your options between life insurance vs. an annuity, an independent insurance agent can help you determine which is the right choice for you and your family. 

Types of Life Insurance Annuities

There are a couple of ways to set up a life insurance annuity. Each option is designed to provide the death benefit payout in a different arrangement. 

• Fixed-period annuities: You might also hear this option referred to as a term life insurance annuity. Fixed-period annuities pay out the policyholder's death benefit to the beneficiary in a series of regular payments over a predetermined period of time, such as 10 or 20 years. 
• Lifetime annuities: You might also hear this option referred to as a whole life insurance annuity. Lifetime annuities pay out the policyholder's death benefit to the beneficiary over their lifetime in a series of regular payments. 

An independent insurance agent can help you choose the right type of life insurance annuity for you and your chosen beneficiary. 

When You Might Want to Choose a Life Insurance Annuity

It's helpful to know why a life insurance annuity might be a preferred option over a normal life insurance policy. You may decide a life insurance annuity is right for you if:

• Your beneficiary wants to enjoy simplified financial management
• Your beneficiary is worried about overspending a large lump sum payout
• Your beneficiary doesn't have any large expenses that need to be paid immediately
• Your beneficiary wants to establish a regular stream of income after you're gone
• Your beneficiary wants the option to earn interest on any amount not paid out

An independent insurance agent can also help you decide if a life insurance annuity is the right choice over a life insurance policy.

Can I Use a Regular Life Insurance Policy as an Annuity?

In a word, no, but there are ways to convert an insurance policy that has accumulated cash value into an annuity. If you were to simply cash out the policy and buy an annuity with the proceeds, the cash you receive that exceeds the premiums you paid would be taxed as income. However, a section of the tax code known as a 1035 Exchange allows policyholders to transfer funds from an insurance policy to an annuity without paying taxes.

Doing a 1035 Exchange rather than surrendering the policy is particularly helpful to people who’ve accumulated cash value in a life insurance policy but find that it no longer fits their needs. This is a common situation for retirees who find themselves in different circumstances than when they bought the policy and had a young family to protect.

Considerations with a 1035 Exchange

There are a few components of your insurance policy to consider before going through the 1035 Exchange process, including:

• The death benefit: The first thing to consider is that you’ll be giving up the death benefit of the insurance policy. Even if you’re no longer working, remember that when one spouse dies, the surviving spouse will receive lower Social Security benefits and possibly lose other retirement income from things like pensions.
• Guaranteed income: In exchange for giving up the death benefit, you’ll gain a guaranteed income for life (or a specific number of years). You can add other options to the annuity. However, you’ll also no longer be paying the premium on the life insurance policy, so your expenses will decrease.
• Insurance coverage: Although you’ll lose the death benefit of the insurance policy, many annuities offer optional riders that provide a death benefit that allows a spouse to continue receiving payments if the owner dies, or even to accelerate payments if the owner is diagnosed with a terminal illness. You can also add a joint option, which will continue the annuity payments until both spouses die. Also, you could use part of the annuity payments to pay the premiums on a term life insurance policy, which are generally less expensive than whole life policies.
• Long-term care: Section 1035 also allows you to exchange your life insurance policy for a long-term care policy tax-free. Since long-term care benefits aren’t taxable, you will never pay taxes on your gains. However, there are a few long-term care insurers that allow you to pay for coverage with a lump sum, which means you would have to arrange a partial exchange every year to pay the annual premiums, and only a handful of companies handle partial exchanges. The better solution would usually be to choose an annuity that includes a long-term care option.
• Taxes: Although a 1035 Exchange is tax-free, you will pay taxes on a proportion of your annuity payments based on the gains you earned on the life insurance.

An independent insurance agent can help you evaluate all components of your life insurance policy to determine if a 1035 Exchange to an annuity is the best option.

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Here's How an Independent Insurance Agent Can Help

When you're ready to choose the right type of product to secure a financial future for your loved ones, no one's better equipped to help than a local independent insurance agent. These agents have access to multiple annuity insurance companies, so they're free to shop and compare many different options for you. They'll help you find and buy annuity life insurance or life insurance with an annuity rider and answer any questions you may have along the way.