Posted on 21 August 2012.
With the stock market stuck in a multi-year trading range and investors worried about the stock market selling off, many investors are asking what are annuities and how does an investment in annuities differ from an investment in stocks? The reason why investors are interested in exploring what are annuities and how they are an alternative investment stocks is the impact of the 2008/2009 financial crisis and stock market crash, which spooked many investors looking for safe places to invest their money for retirement. Annuities offer relatively safe investment returns that are well above the returns provided by low yielding savings accounts, certificates of deposit (CDs), and highly rated bonds.
What are annuities in a nutshell? Annuities are contracts that spell out fixed payments that are made on an initial investment for a specified number of years. Annuities are only offered by life insurance companies, due to government rules and regulations. Any investment gains achieved while annuities are held in annuity accounts are tax-deferred until the money is withdrawn by the investor. Annuities are available as either fixed annuities or variable annuities. Fixed annuities provide fixed rates of return that are high compared to many other safe investment alternatives, but less than variable annuities. Variable annuities provide variable rates of return that are usually more than fixed annuities, but are dependent upon the returns of their underlying assets. Variable annuities can either provide guaranteed rates of return for additional fees or variable rates of return that can be positive or negative, based on the performance of the underlying assets.
Although investors looking into what are annuities may like the relatively safe returns that they offer that can be guaranteed for additional fees, annuities do not make sense for every investor, especially those with little time left before retirement to recover from the high sales commissions that must be paid to buy annuities. Additionally, annuities often charge steep early termination fees of up to 10% for those who pull their money out of annuities before the contracts officially expire, which means that investors that are not sure if they can lock up their money for long periods of time in annuities should look at more flexible investments. The most extreme risk associated with buying annuities is the remote possibility that the life insurance company that sold an investor annuities goes bankrupt and the annuities suffer total loss of value due to inability to make the promised payments. To mitigate this risk, annuity investors need to find out the amount of annuity insurance coverage that life insurance companies within their state are required to maintain, which is between $100,000 and $500,000 per annuity contract.
Investors with long term investment horizons may find annuities to be an attractive investment alternative to the highly volatile stock market once they understand what annuities are and have located suitable annuities to invest in . The key to investing in annuities safely is to buy annuities that offer either a fixed rate of return or a guaranteed variable rate of return, and to buy annuities in amounts that are covered by the annuity issuer’s annuity insurance.
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