Moliciero Financial | Investing and Financial Planning

Annuities and Life Insurance

You have probably encountered both annuities and life insurance before. These are the two primary products the insurance companies sell to protect your life over the long term. The concepts of an annuity and a life insurance policy are exact opposites.

An annuity is intended to protect a person from outliving his retirement assets, The annuity protects you, and possibly your family, from your living too long. A life insurance policy protects your family from your dying too early. Both concepts are extremely important and useful in your overall financial plan at any point in time.

Many times both annuities and life insurance policies are marketed as investments by the insurance agents. In addition to all the guarantees, they can make a very good case for why you should view these products as investments. This is the subject I will address here.

To understand if annuities and life insurance are viable investment products, we need to first review the basic types of policies sold by most insurance companies.

Annuities

There are 3 types of annuities being sold by insurance companies today. Each of these will have various offshoots or sub-products, but the all products follow these 3 concepts.

The first concept is the fixed annuity. This is the product most people are familiar with. You contribute an amount into an insurance company, and are guaranteed to earn a certain interest rate and payments when you retire. If you put in money over time or all at once, and receive your payments later when you retire, you have a deferred fixed annuity. If you deposit a lump sum of money now and begin to receive payments immediately, you have an immediate fixed annuity.

The second concept is legally a form of fixed annuity, but is different enough that it is usually listed as a separate form of annuity. This is the equity indexed annuity. On the surface, this annuity looks like a regular fixed annuity and has similar guarantees. However, the interest rate credited each month is not fixed, but changes to match the performance of an investment index, such as a long term bonds or even a stocks. You still get a minimum interest rate credited but benefit from the potential gain in the investment index.

The third concept is the variable annuity. This annuity actually allows you, as the contract owner, to select the investments that will be purchased with your contributions. Most contracts offer a wide array of mutual funds that can be used for this purpose. The amount you eventually receive each month at retirement will be dependent on the performance of the investments you selected. Due to the investment component, variable annuities are governed by the security laws and regulatory agencies, as well as the insurance laws and state commissioners.

There are many versions of each of the above annuity concepts. Each comes with a more impressive name then the next. They are also marketed in a number of ways so that the potential buyer will think these are investments sent from heaven.

Life Insurance

Life insurance products have also developed over the years to give more investment flexibility to the policyholder. All the products come under several general concepts.

The first life insurance concept is term insurance. This type of insurance has no cash value component, only pure insurance. Therefore, it cannot be considered an investment product.

The second type of insurance is whole life insurance. This type pays the face amount on the policy if you die, but also builds up cash value while you are alive and paying premiums. The cash value can be withdrawn by you or used to buy an annuity later on should you have no further need to the insurance coverage. So, a whole life policy is an insurance concept which can also be viewed as an investment while you are alive.

The variable life policy is the third concept. Similar to the variable annuity, a variable life policy allows you to invest the cash value of the policy in various mutual funds. Your eventual cash value and the face amount of the policy both adjust to reflect the investment returns of the investments you select.

Marketing of Annuities and Life Insurance Policies as Investments

You will see many advertisements using annuities as investments. This is logical since a deferred annuity is a vehicle for accumulating money, whether it is a fixed annuity or variable annuity.

You will never see a commercial touting the investment benefits of a life insurance policy. Even though there is a cash value accumulation, life insurance is marketed for protection, not investment.

The sales approach of insurance agents is another matter. These people will devise various sales pitches to convince you that both an annuity and life insurance should be in your investment portfolio. These sales presentations can be quite compelling since they emphasize the benefits in a given situation.

If you see a projection chart showing how you can accumulate $1 million at retirement under either an annuity or life insurance, with a relatively cheap payment each month, you are going to listen and get interested. They never do a comparison with other investment products because this would then bring up the disadvantages of using an annuity or life insurance as an investment. Along with the investment projection, they then tout all the guarantees that you get under these contracts and policies.

Annuities as Investments

Would you consider investing in an annuity if you can invest in a 401k? You probably would not, but you should look at the advantages of an annuity. Most financial planners would advise against opening an annuity due to the high expenses involved in these contracts. However, there is one psychological point which most financial planners do not focus on. That point has to do with the lack of security in retirement if the 401k is your only form of retirement savings.

Retirees who might have $1 million or more in a 401k still report their being financial insecure. The reason is that they don’t know how long they will live, and therefore, don’t know how much they can withdraw each month. The financial planner can give them a lot of projections, but they cannot give them a feeling of security. The payments are not guaranteed for life.

Having an annuity at retirement gives the retiree a feeling of security. If he lives to 110, he will continue to receive a check each month. No other financial product can offer the security of an annuity. For this reason alone, you should consider adding an annuity as part of your overall retirement savings program. Of course, you need to read up on the advantages and disadvantages, and compare to other investments. Just don’t discount the security factor.

Life Insurance as an Investment

A good sales presentation on life insurance will include projections of the cash values after 20 or 30 years. The numbers can really be eye popping when you see the size of the value, which you can withdraw anytime you want. The problem with using life insurance as an investment are the costs and being at the mercy of the insurance company in how much you will earn on your money. You are paying for protection against dying early. On top of that, you pay for high annual expenses under the policy. If you do not need the insurance, these costs will make a life insurance policy the least favorable investment for retirement. You will realize this during the sales presentation, at which point, the sales agent will then tout the life insurance protection you get along with the investment.

You should never consider investing in life insurance policy unless you need the insurance protection for you and your family. Protection against dying early is the reason you buy a life insurance policy. Having a cash value in the policy is a secondary consideration.

Annuities and Life Insurance have their Place

An annuity should always be considered for long term security. You may decide against an annuity given the costs and your particular situation. However, you should not ignore the advantages of an annuity merely because you will be committing money long term to a rather inflexible investment. Picture yourself in retirement having the security of a monthly check coming in.

Life insurance definitely has its place in your financial plan. In fact, life insurance and other insurance coverage is one of the first areas a financial planner will review. Safety first is the general theme. You can and should consider your life insurance cash values when planning for retirement. When you no longer need the life insurance, such as the kids are grown and gone, these cash values can be used to provide a comfortable retirement. Again, if you do not need to buy life insurance protection, look elsewhere for a place to invest for retirement.

 

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