What’s annuity life insurance?

If you have a life insurance policy when you die, your beneficiaries will receive a death benefit from the insurance company. Most insurers pay the death benefit as a lump sum payment, where the entire benefit is paid at once and shared between the eligible beneficiaries. With annuity life insurance, the insurer converts the lump sum payment into a stream of income.

An annuity life insurance is a method of paying death benefits over time. It converts a beneficiary’s payout into a series of payments that are paid over a specified period and any remaining benefits continue earning interest. The insurer will pay incremental benefits as agreed upon with the beneficiary until the payout is complete or over the beneficiary’s lifetime.

How annuity life insurance works

When a beneficiary chooses to receive death benefits as an annuity, the insurance company converts the beneficiary’s payout to a life annuity that is paid out over time, and any remaining death benefit continues to grow.

When the death benefit is converted to an annuity, the insurer pays out the benefit in incremental installments as agreed upon, usually for a set number of years or until the beneficiary passes away.

If the beneficiary chooses a longer timeframe for the annuity, the death benefit will earn more interest, resulting in higher payouts. The annuity earns a fixed rate of interest that is determined by the provider. The income you receive from the annuity life insurance may be partially taxable; the interest portion of the installment payment is taxable at your tax bracket, but you won’t pay taxes on the death benefit.

How long does annuity life insurance last?

Life insurance annuities may have different timelines depending on how long you agree to receive payments. Here are the options you have:

Fixed-period annuities

These annuities make payments over specific periods, typically ranging from 10, 15, and 20 years. If you die before the specified period lapses, the insurer will make the remaining payments to your beneficiaries. This option is ideal for older people who want to be sure that any amounts owed after they pass away are paid to designated beneficiaries.

Lifetime annuities

These annuities pay benefits over the beneficiary's lifetime and stop when they die. Lifetime annuities are ideal for younger people who want to receive payments over a longer time so that the money has enough time to grow. Annuity payments stop after your death, whether it occurs in a few years or the distant future.

Annuity life insurance vs. life annuities

A life insurance annuity differs from a life annuity, even though both products are provided by insurance companies.

Life annuities are investment products that you purchase to supplement your retirement income. You will pay a lump sum or series of payments to fund the annuity, and the insurer will pay you a stream of income for the duration of your lifetime. The annuitant may be you the owner, or another person you have designated as a beneficiary, depending on the type of annuity you have.

In comparison, a life insurance annuity is a payment method that is provided to the beneficiaries of a life insurance policy who are receiving a death benefit. Generally, the death benefit is paid to the named beneficiaries upon the annuitant's passing. Therefore, there must be a qualified death for the life insurance to put out benefits to beneficiaries.

Who should get annuity life insurance?

Insurance companies may offer life insurance annuities as a payment method, but not all insurers offer this option. When filing a claim for death benefits, you should ask the insurance company about using the annuity option as a payment method.

Most insurers pay death benefits as a lump sum payment to help the beneficiaries pay for burial expenses, estate debts, and other costs left behind by the deceased policyholder. You can also use the remaining funds to invest in investments with potentially higher returns.

However, receiving a substantial lump sum payment can be overwhelming, and you may have more money than you expected. If you are not prepared to manage a lump sum payout, you can choose to receive the payments as an annuity to make it easier to budget the money. A life insurance annuity can improve your chances of making the death benefit last over the long term.

Pros of annuity life insurance

Replace income

If you were receiving a regular income from your spouse or parent before their death, annuity life insurance can replace the income you were receiving with a series of payments. These payments will be spread over a specified period or over your lifetime.

Prevent overspending

If you receive an unexpected lump sum payment as a death benefit, it is easy to spend the money on unplanned expenditures. However, annuity life insurance spreads these benefits into a series of payments so that the money lasts a long time.

Better money management

When you receive a substantial payment at once, you may be unsure of where or how to begin investing, and you may make investment mistakes. However, an annuity provides better money management since the beneficiary receives a series of payments over their lifetime or over a specified period.

Cons of annuity life insurance

Lack of control

Once you choose to receive annuity payments instead of a lump sum payment, you cannot go back on your decision. The decision is generally irrevocable unless the annuity contract allows a buyout option. In this case, you may be able to cancel the annuity but with a huge penalty.

No lump sum cash is available

When you choose to receive death payments as an annuity, you won’t have a lump sum to pay immediate expenses like funeral expenses, medical expenses, or debts left behind by the deceased or debts you owe.

Low investment return

Annuities have a low rate of return compared to other investments like mutual funds and stocks. You would get value if you invested the money in alternative investments with higher returns.