What is the difference between investing in a life insurance policy and investing in an annuity?
Which one is best for investment purposes?
Strictly speaking, a life insurance policy and an annuity are like mirror images of each other. A life insurance policy pays a lump sum at death… after a series of smaller payments while you are alive.
On the other hand, an annuity pays a series of payments for the rest of your life… after payment of a lump sum at the beginning.
However, there are lots of “riders” and other features that can be added to each policy to make them serve other purposes. For instance, you can add an accumulation phase to the annuity, so you don’t have to have the lump sum upfront. You can add an insurance feature, so your heirs can get your money back if you don’t live very long, and you can add a second person, so the annuity pays out for whoever lives longer, etc.
Term life insurance policies provide zero investment features and provide straight life insurance at the lowest cost. To make an insurance policy into an investment, you need other features. The simplest feature is a “return of premium” rider. With this rider, in exchange for a slightly higher annual premium, you get all your premiums back at the end of the term. That may make it an investment but still doesn’t make it a good investment. After all those years, simply getting depreciated currency back means you actually lost however much purchasing power was inflated away. But you will have gotten insurance coverage during that period in exchange for the loss of the use of that money (and any return that money may have generated).
A “Whole life” policy doesn’t last for a specified term but instead has an accumulation portion that builds up value while you are younger so that it can fund the cost of insurance when you are older, and the insurance cost itself would be prohibitive. It also generally has a provision to allow you to borrow your own money back from the insurance company thus impairing its ability to fund your future insurance needs.
As far as an investment, although insurance agents might try to convince you that an insurance policy is a good investment… generally, they aren’t. It is like saying pliers make a good wrench. They may get the job done, but they generally aren’t the best tool for the job.
If you want insurance buy insurance, if you want a guaranteed income for life, buy an annuity. If you want a guaranteed return on an investment you might want to look at the accumulation phase of an annuity… but you could also look at a bond or fixed-term deposit. If you only have a hammer, (or if you get a commission for driving nails)…everything looks like a nail. To get the right tool for the job you need unbiased advice, so do your homework and beware of commission-based insurance salesmen.
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