What is a life insurance annuity?
While most life insurance policies pay out the insured's death benefit in a lump sum, some insurers provide beneficiaries with the option to receive their payout as an annuity, or in payments over time. Life insurance annuities, or installments, allow the unpaid death benefit to earn interest until it's fully paid out, and they allow for a steady stream of income for the beneficiary. A life insurance annuity is different from a life annuity, which is a retirement tool that pays out under certain qualifying events to the designated annuitant, which could be the person who purchased the annuity or someone else, depending on the product.
What's the difference between life annuities vs. life insurance annuities?
A life insurance annuity is not the same as a life annuity, though both can be provided by insurance companies. A life annuity is a retirement investment product you can purchase. A life annuity earns interest for a set timeframe or until certain conditions are met and then starts paying out to the annuitant. The annuitant may be you as the person who purchased the annuity, or someone else you've designated, depending on the specific annuity product you have. On the other hand, a life insurance annuity is a payout method that may be offered to the beneficiaries of a life insurance policy.
Is an annuity a life insurance policy?
No, an annuity is an investment product you purchase all at once that earns interest and, after a set time frame or when certain conditions are met, starts paying out. It may be offered by life insurance companies, but it's not technically a life insurance policy.
How life insurance annuities work
While technically different from a life annuity investment product, a life insurance annuity essentially involves converting a beneficiary's payout to a life annuity so it can be paid out over time and so the remaining death benefit can continue earning interest. Once converted, the insurer can pay out the benefit incrementally as agreed upon with the beneficiary — for a set period until the payout is complete or until the beneficiary passes away.
Selecting a longer timeframe for your life insurance annuity can result in more earned interest and thus a higher overall payout. Beneficiaries don't have to pay the insurer if they choose the life insurance annuity payout option, but the interest earned during the annuity period might be subject to income tax. Consult with a tax professional to understand the tax implications of your particular circumstances.
Should life insurance beneficiaries choose the annuity option?
Life insurance annuities aren't available in all situations, so when you file a claim for a death benefit, ask about your payout options. Receiving a lump sum can make it possible to pay for burial expenses and estate costs, or other large financial needs you might have coming up. A lump sum payout can also be invested, allowing you to earn interest on your benefit with potentially more lucrative options than an annuity payout.
However, if you're not prepared to invest and manage a large lump sum payout, receiving a series of payments via annuity can make it easier to budget while still earning interest at a fixed rate. Again, a tax or financial advisor can help you with this decision.