04 Feb Term insurance or an annuity?

Q. I was speaking to a life insurance salesperson about term insurance, and he’s recommending an annuity – not the kind that pays now — to cover me for both insurance and investments. I know these are expensive. How do I know if an annuity could be right for me?
— Underinsured

A. An annuity could be right for you, but we’re a little concerned about the salesperson’s motivations.

More on that in a moment.

First, term life insurance and annuities serve different purposes.

Term insurance pays when you die, protecting your family from financial loss, said Ed Gaelick, a Chartered Life Underwriter and Chartered Financial Consultant with PSI Consultants in Glen Rock. Compare that to an annuity, which would pay you while you’re alive, protecting you financially from living too long.

“There are many variations of annuities, some that have market risk, some that don’t. Some that pay out immediately, some that delay payout,” Gaelick said. “Some may also protect the `principal’ or the amount invested from market losses but only if you should die. That can be interpreted as a life insurance death benefit, which it is not.”

Annuities can be an extremely valuable tool for investors to use in retirement income planning, but they should not be considered a life insurance replacement.

An annuity is a financial contract purchased from an insurance company, and it is designed to help turn your retirement savings into a guaranteed stream of income that lasts as long as you live – starting either right away or at some point in the future, said Matthew DeFelice, a certified financial planner with U.S. Financial Services in Fairfield.

He said this can be equated to “longevity” insurance, or in other words, protection against the scenario where you outlive your assets.

“With an annuity you are transferring the risk of living too long to an insurance company,” DeFelice said. “With life insurance you are transferring the risk of dying too soon to an insurance company.”

While both annuities and life insurance policies can provide you with a death benefit, DeFelice said, but the two should not be confused.

He said there are several different types of annuities you can purchase. He offered some examples:

A fixed annuity will guarantee your principal and grow it at a contractual minimum rate of return, with the actual interest rate paid usually determined by prevailing interest rates.

A variable annuity allows you to select from a variety of mutual funds held in separate sub-accounts, with the potential for higher returns but also to lose money.

An indexed annuity will guarantee your principal and typically link your return to the performance of a stock market index like the S&P 500, with a pre-determined cap on the upside.

“You can take income from any of the above now or later,” he said. “A deferred annuity lets you accumulate money so that at some point in the future you can begin taking income, while an immediate annuity converts a lump sum into guaranteed income right away.”

DeFelice said variable annuities do contain extra fees and charges such as mortality and expense charges, sales and surrender (early withdrawal) charges, administrative fees and charges for optional benefits and riders.

“It sounds like the life insurance sales person you are speaking with is recommending a deferred variable annuity if he is saying it will `cover you for both insurance and investments,'” DeFelice said.

He said some deferred variable annuities will guarantee that your beneficiary will receive at least the amount of your original principal if you die, even if the value of the annuity has declined due to poor performance of the mutual funds you selected.

“However, if you have a need for $1 million in guaranteed death benefit now, you’d have to fund the variable annuity with a large amount up front which may or may not be feasible,” he said. “Comparatively you can purchase a simple 20- or 30-year $1 million term policy for a relatively inexpensive annual premium – assuming you are in good health and insurable.”

So is an annuity right for you?

Based on the information you provided, it’s impossible to tell.

DeFelice said it would depend on a variety of factors, such as your age, family needs, general health, liquidity needs, whether or not you have a traditional pension, other assets like investment accounts and retirement plans, and more.

He would need to look at your whole financial picture before considering any financial product purchase.

“I would, however, question this agent’s motivation for recommending you skip the term life and just buy an annuity for both investments and insurance without running a proper needs analysis,” DeFelice said. “Chances are he stands to potentially make a lot more money selling you the annuity than he does with a basic term life policy, and without more information it’s hard to say whether he has your best interests in mind or his own.”

Gaelick said the best advice is for you to decide what exactly you are trying to protect. Then you can decide on the best product.

“If you spoke with an advisor about life insurance and they recommended an annuity instead, run away fast,” he said.

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This story was first posted in February 2016.