Traditionally, older generations have been the primary target audience for annuity companies, whereas life insurance is often recommended to younger people.
How should financial professionals talk about the differences between annuities and life insurance, and at which age might each product be appropriate? We’ll provide some talking points and important information that may help you guide the conversation with clients.
Life insurance vs. annuities
Educating clients about the differences between life insurance and annuities can help them make financial decisions that align with their needs and values both now and in the future.
For starters, it might help to explain that both are types of insurance products. For life insurance, that’s common knowledge among many individuals, but not always understood with annuities. Here is a simple way to explain how each functions differently.
Life insurance policies are designed to help protect the family or heirs of a policyholder in the unfortunate event the policyholder passes away, helping to replace lost income so a family can maintain a certain lifestyle. In general, life insurance is purchased to offer financial assistance to others and premiums are paid monthly, quarterly, or annually.
Annuity products, on the other hand, are intended to protect the purchaser’s financial future by providing options for a guaranteed stream of income in retirement. While many annuities offer a death benefit, they are generally purchased with an up-front lump sum to benefit a person while they are still living.
The pros and cons of annuities vs. life insurance
Like many insurance products or investment vehicles, there is a time and place for each. When assessing an individual’s needs, age isn’t a sole deciding factor. Financial professionals can generally help determine whether an annuity or life insurance (or both) is in a person’s best interests based on the following criteria.
Retirement horizon & risk tolerance
A person’s retirement horizon plays an important role in their investment strategies. Younger generations have more time to earn compound interest and make up for potential market downturns. As such, they generally don’t need to be as conservative with their investments as older generations because they have more time to ride out market volatility. Directing funds toward their 401(k) is generally encouraged, as is protecting their family by way of life insurance.
Those approaching retirement may have more to lose if they place their money in risky investments because they have less time to recoup any dollars they might lose. Generally, older investors want to make sure they won’t outlive their savings. That’s why annuities — which typically have guaranteed returns or limits on loss — can be attractive to older investors.
Cash on hand
Annuities and life insurance both come at a cost, but the ways in which those dollars are spent vary. Most types of annuities require a sizable lump sum payment up front. Younger individuals may not have saved up enough money to purchase an annuity. Furthermore, it may make more sense for any savings they accrue to go toward a downpayment on a house, college tuition for their children, or an emergency fund.
Older generations may already have paid for many of life’s big expenses, and they’re typically more able to make lump sum payments for annuities, in addition to paying for any associated fees or administrative costs.
Potential tax benefits
Life insurance and annuities may both offer tax benefits. Generally, life insurance proceeds that are received by a beneficiary because of the death of a policyholder are not considered income and don’t need to be reported to the Internal Revenue Service. Only income that is earned from interest on those proceeds would be taxable. There may be exceptions, however, if the policyholder chooses to cash out the policy.1
Remind clients that annuities purchased with pre-tax dollars generally grow tax-deferred, meaning they’ll pay income taxes only when they withdraw money or begin receiving payments. If the annuity was purchased with post-tax dollars, taxes will only be owed on the annuity’s gains. Clients should also understand the potential penalties associated with withdrawing from an annuity before age 59½.2
Final thoughts
So, how young is too young for an investor to purchase an annuity? There are no clear-cut answers, and there are always exceptions to the rule. For example, what if a high-earning younger client has a robust portfolio, life insurance and an emergency fund, plus they’ve maxed out their 401(k) and IRA contributions and are still being heavily taxed on their income? If they have a large sum of money left over and are looking for a tax-deferred vehicle, an annuity might be a consideration.
Also consider that new annuity products have been designed with the potential for market-linked growth that may rival the returns of traditional investing over time. As a financial professional, it’s important to stay informed of innovative annuity products that can serve the diverse needs of your clientele, like those offered by TruStage™.
Explore our annuity products and reach out to us to learn more or to become appointed.
