Categorized | Investing, Retirement

Annuities Offer A Safe Investment Alternative


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Annuities Safe Investment
Annuities offer a safe investment alternative to the volatility associated with direct investments in the stock market.  After enduring two major bear markets in stocks and heightened stock market volatility over the past fifteen years, many investors are looking for ways to earn decent returns on their long-term investments without subjecting them to the risk of major losses.  Annuities provide safe and substantial investment returns, for a cost.

Why Annuities Are Attractive Investment Vehicles

AnnuitiesThe reason why annuities are attractive investment vehicles is because they offer guaranteed and relatively high rates of return.  At a time when investors are still living with the memory of the 2008 / 2009 stock market crash, there is great demand for investments that do not subject people’s life savings excessive risk associated with stock market volatility and bear market sell-offs.

The low interest rate environment that has existed since the 2008 / 2009 recession has caused traditional fixed-rate interest bearing savings and investment vehicles, such as savings accounts and money market accounts, to provide paltry returns of less than 1%.  Certificates of Deposit (CDs) are not paying much more by way of interest than savings accounts, and require money to be locked away for a period of time.  The combination of investors looking for safety and decent rates of investment return has driven many to explore annuities as an investment option that offers both safety and relatively high rates of investment return.  Of course, it is important to understand the benefits and drawbacks of making an investment in an annuity.

What Are Annuities | An Explanation of Annuity Investments

Annuities are able to offer safe investment returns because they are not freely trading securities that are priced based on market supply and demand forces.  Instead, annuities are contracts that provide guaranteed payments to the purchaser over a period of time.  An annuity is only available through a life insurance company, which invests the money provided to them by the buyer of an annuity.  The seller of an annuity makes periodic payments to the buyer per the contract terms.  The payments can begin soon after an annuity is purchased or years later during retirement, based on the contract term.  Increases in the value of an annuity are not taxed until the money is withdrawn, at which point the money is taxed as regular taxable income.

While there are many varieties of annuity products available, annuities fall into two broad categories:  fixed annuities and variable annuities.  Fixed annuities are just as they sound, they offer a fixed rate of return that is set and clearly defined when the annuity contract is signed between the buyer and the seller.  Variable annuities provide rates of return that vary over time, based upon the terms of the contract and the value of the assets that the annuities invest in.  Variable annuities offer higher rates of return than fixed annuities, but carry with them more uncertain returns, due to market fluctuations in the underlying securities, which can include stocks and bonds.

Since investors invest in annuities to free themselves from the risk of investment losses, life insurance companies offer a guaranteed versions of their variable annuity products that guarantee a minimum rate of return regardless of the performance of the underlying assets.  Guaranteed variable annuities usually have higher fees than other types of annuities, which many investors consider to be a small price to pay for guaranteed returns and avoidance of losses.

Guaranteed annuities that invest in stocks are designed to be winning investments for investors who still want to participate in the stock market, but also want to remove the risk of losing money in a stock market downturn.  Guaranteed annuities allow investors to take advantage of stock market gains and avoid stock market losses.  If the underlying stock market indexes go up in a calendar year, then the annuity investors benefit by earning a rate of return on their annuity investment that is comparable to stock market index gains, minus any management fees assessed by the managers of the annuity.  The gains are reflected in the value of their annuity holdings at the end of the calendar year.

The guarantee comes into play when stock market indexes experience a losing year.  Guaranteed annuities are designed to pay a minimum rate of return, no matter how their underlying stock holdings perform, which means that even during years that have stock market sell offs, holders of guaranteed annuities do not lose money.  They may not make much money, as the guaranteed returns are quite modest, in the range of 1% to 2%, but a modest gain during a year of stock market losses is something many investors are happy to earn.

Annuities Are For Making Long-Term Investments

Annuities Offer A Safe Investment
While annuities offer safe investment returns, annuities fees that are considerably higher than many other investments.  Management fees for annuities tend to be higher than other investments, such as mutual funds and index funds.  They also lack the liquidity of many other investments, as annuities cannot be liquidated fully without incurring substantial penalties, which are known as “surrender fees”.  For these reasons, annuities are only suitable as long-term investments.  To take advantage of the benefits offered by annuities, money needs to be invested in them for a long period of time.  For short or medium terms investment horizons, money would be better invested elsewhere in more liquid investments with lower fees.

Annuity Risks

The one substantial risk associated with investing in annuities is the risk that the life insurance company that sells and manages one’s annuity goes bankrupt and is unable to live up to the obligations of the annuity contract.  Life insurance company bankruptcies are rare, so the risk is minimal.  Even so, life insurance companies that sell annuities are required to provide annuity insurance coverage of at least $100,000 to cover losses in the event of bankruptcy.  This means that it is important to ensure that annuity investments do not exceed a life insurance company’s insurance threshold.  Annuity investments greater than $100,000 should be spread among several life insurance companies to mitigate risk of losses associated with bankruptcy.

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