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Annuities Explained

While some investors can tolerate some volatility within their portfolios in return for higher profits, others (particularly investors who are risk-averse or nearing retirement) cannot endure watching their investments bouncing up and down every day. This is where annuities can be used as a very useful investment tool.

What are Annuities

An annuity represents a contract that is signed between the buyer (the annuitant) and the insurance company. Under the conditions of this contract the insurance company makes the commitment to pay the annuitant a certain amount of money, over a particular time period, on a periodic basis.

Additionally annuities provide a type of retirement-income insurance. In exchange for the funds you contribute regularly to the annuity you receive certain income later in life. Therefore annuities are often used by investors who want to ensure they will have a minimum income stream after they retire.

Annuities can provide fixed periodic payments or variable payments.

Investors who are looking for a very low-risk retirement usually choose a fixed annuity. This guarantees them a fixed monthly income for the rest of their life but deprives them of growth opportunity.

Those who choose a variable annuity receive a minimum income stream plus an additional payment amount that varies depending on the performance of the annuity's investments.

Annuities Pros and Cons

Annuities can be beneficial under a number of conditions. One of the advantages of annuities is that the user enjoys tax-deferred growth and compounding of your money.

The rates of return on your money are guaranteed, which also applies to lifetime payments in case you decide to annuitize.

There are various other features of annuities that can be beneficial to you. You should take a closer look to determine which ones apply for your condition.

The strength of the guarantees is dependent on the strength of the issuing insurance company. This means that you don't have good prospects if the insurance company fails. In order to reduce this risk to minimum it is advisable that you use the services only of reputable and strong insurance companies.

Annuities have their negative sides as well. One of them is that you have to pay for the guarantees you get.

Additionally, examine the surrender periods. The reason for doing so is that your money can be locked up for a longer time period than you actually would like.

As a long-term, retirement planning instrument, annuities usually come with penalties if you withdraw your funds before a certain minimum number of years have passed. However, most annuities will allow you to withdraw about 10-15% of your account in case of emergency without penalty.

Finally, you should examine the characteristics of annuities from various aspects so that you determine whether they are appropriate for your financial situation. Annuities work perfectly for some people, whereas for other they bring only headaches.

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