What is a Life Insurance Annuity?

Trevor Wallis
Trevor Wallis
Contributing Writer

You’ve spent your entire career building a nest egg for a relaxing retirement, but how do you make sure your money doesn’t run out when you need it most? A life insurance annuity can help spread your money out into consistent monthly payments throughout retirement. With annuity insurance, your retirement savings have a guaranteed benefit, meaning your money will be safe from stock market plunges or falling bond prices. This makes your retirement cash flow much more predictable and stress-free.

How does annuity life insurance work?

An annuity is a contract between you and an insurance company. You contribute premiums and the company pays you when you meet specific criteria — kind of like your traditional life insurance policy.

However, the most significant difference between life insurance and a life insurance annuity is the criteria to receive payment. Instead of receiving a lump sum when you die, an annuity takes your premium and converts it into regular monthly payments for the rest of your life. You can either contribute one lump sum — a good option if you’re near or already into retirement — or contribute monthly premiums until you’re ready to start receiving payments.  The insurance company will set your monthly payment amount based on how much you contribute and your age when you start receiving payments.

Types of annuities

There are several life insurance annuities to choose from. Understanding how each type works will help you better understand them and choose the option that helps you reach your financial goal.

  • Fixed annuities are consistent and predictable, making them extremely popular for retirees. According to the Insurance Information Institute (III), fixed annuity sales have increased by 36% since 2015. With a fixed annuity, the insurance company guarantees a rate of return and payment amount either for a set number of years or for the rest of your life.
  • Variable annuities give you more control over how your contribution is used within the contract. You can choose from underlying mutual funds to take advantage of market growth while still having a guaranteed benefit to protect you from significant market downturns.
  • Fixed-indexed annuities are fixed annuities with the chance for a higher interest rate when the index it’s tied to —  like the Dow Jones Industrial Average — is positive. However, fixed-indexed annuities do have growth limits and don’t earn dividends, making the rate of return smaller than the index itself. You make up for the lower returns with a guaranteed minimum interest rate on your contribution.
  • Immediate annuities require a lump sum payment and begin paying out immediately. This option is great for retirees who have a substantial nest egg but are concerned they’ll blow through it too quickly. Immediate annuities can be fixed, variable or fixed-indexed.
  • Deferred annuities set a first payment date sometime in the future. You can either contribute a lump sum or make regular premium payments to increase your annuity over time. The insurance company will pay the contracted rate of return back into your total until you begin receiving payments. Deferred annuities can also be fixed, variable or fixed-indexed.

Benefits of a life insurance annuity 

The best life insurance companies are reliable, tenured and stable, making it an excellent home to protect your money through retirement. 

“Annuities are marvelous and versatile tools to provide financial growth and stability over long stretches of time,” says Dr. Jeffrey Crum, a financial services professional with MassMutual Carolinas. “Insurance companies are some of the strongest and most stable companies, and they are designed to be the very best at playing the long game.”

Choosing an annuity for your retirement can secure guaranteed monthly cash flow for either a set number of years or the rest of your life. This helps preserve the money you’ve saved during your career for you and your family.

Risks of a life insurance annuity

Life insurance annuities are complex and difficult to understand, leading many people to buy in without completely understanding the fees and return structure. While annuities provide stability and downside protection, they aren’t designed for growth like an investment account, and the monthly disbursements don’t grow with inflation. All of your payments will be taxed as regular income, which may leave you with a hefty tax bill if you have a large payout.

Annuity fees can also catch people off guard. Annuities carry some of the highest commissions for insurance agents, which come from your contribution. Depending on your issuer, you may have to pay a surrender charge if you withdraw over the allowed amount in a given year.

How to select the right plan for you

Before you talk to an insurance agent or financial advisor about buying an annuity, you should research your options. Do you need the payment now or in the future? If you’re already retired and want to spread your savings evenly, you may lean toward a fixed annuity, while those who won’t need the payment for a few years can take advantage of higher returns through a variable or fixed-indexed plan.

When you speak with your insurance agent, ask about all the fees involved, including the initial costs to set up your annuity, ongoing maintenance fees and the surrender charge if you decide to cash out your annuity early.  You should also discuss the minimum guaranteed return and options for passing on any additional funds to your inheritors.

While your insurance agent may present you with several great options, always compare costs and options from different insurance companies to make sure you choose the best plan for your retirement.

Companies that offer life insurance annuity

American Insurance Group (AIG): Best for variable annuity options

American Insurance Group (AIG) is the largest writer of annuity contracts in the United States. It offers several options for both immediate and deferred variable annuities that allow you to compare fund performance and mix asset classes as you would with a brokerage account.

New York Life Insurance Company: Best for long-term stability

If you want an insurance company that can withstand the tests of time, New York Life is for you. Founded in 1841, the company carries an AA+ rating from Standard & Poor’s — the second-highest rating available. If you choose New York Life as the issuer for your annuity, you can trust its stable track record over nearly 180 years to protect your retirement savings.

About the Authors

Trevor Wallis

Trevor Wallis Contributing Writer

Trevor Wallis is a personal finance writer for Reviews.com. Over the last year, he has covered credit cards, insurance, banking, and more at The Simple Dollar and NextAdvisor.