DETRIMENTS OF VARIABLE ANNUITIES

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DETRIMENTS OF VARIABLE ANNUITIES

Variable annuities are growing in popularity among seniors, which is concerning given that variable annuities don’t make sense for most investors.  The detriments associated with variable annuity vehicles far outweigh any alleged benefits conferred upon the investor.  Here are some of the drawbacks to variable annuities:

  • Income deferral is utterly irrelevant when the annuity is held in an IRA or 401(k).
  • The growth of an annuity is fully taxable as income.   When the owner decides to begin taking money, either as a stream of income or as a lump sum payment, the income will be taxed at ordinary income rates.  This is the case for the owner or his or her heirs.  When compared to the growth of index funds, which are taxable as capital gains to the investor and subject to zero income tax to heirs, the detriment of the variable annuity becomes obvious.
  • Variable annuities are very expensive investment vehicles, and have fees, as well as charges for mortality insurance associated with them.  Typically, variable annuities have an investment management charge of .25 to 1 percent (or higher) per year.  They also have a Mortality and Expense (M&E) fee of 1 to 1.5 percent.  Furthermore, the mortality insurance only pays if the investment diminishes in value AND the investor dies before he or she annuitizes.  The annuities that defendants recommended for the Claimants included contingent deferred sales charges, administrative charges, mortality and expense risk fees, service charges, and other portfolio expenses.
  • Annuities promise a guaranteed income for life, however, if the investor chooses to annuitize the contract, two things happen.  First, the investor sacrifices the principal, and when he or she dies, zero will be left to his or her heirs unless special coverage is purchased at additional costs.  Also, if the investor wants to take cash out for any reason, he or she can’t because the money belongs to the insurance company, and is no longer the investor’s.  Second, in exchange for giving the insurance company all of the investor’s money, the insurance company promises to pay the investor a certain amount for a long as he or she lives.  However, the amount the insurance company pays is typically extremely small.
  • Beneficiary designations are irrelevant when the variable annuity is inside an IRA or 401(k) plans because these plans already provide for beneficiary designations outside of probate.
  • The fees, charges, and expenses associated with variable annuities typically are not detailed on monthly, quarterly, or annual statements.  In fact, many firms include a line item for “fees” and fail to include the fees that are associated with the variable annuity.  The reason these fees are not included is due to the fact that firms take the fees and charges out of the vehicle’s growth prior to distribution.  In other words, the charges are netted out of the gross amount of growth, whatever is left is then detailed on performance statements.  Because of this procedure, the fees associated with variable annuities are hidden, and investors are unable to see the actual costs associated with the variable annuities.
  • The sub-accounts that make up the investments in a variable annuity have their own fee/expense structures that further increase the costs associated with variable annuities.

The financial press has also highlighted the detriments of variable annuities:

  •  “Although variable annuities can pay off in very limited circumstances…, most investors will do better buying and holding mutual funds outside rather than inside this tax shelter.”  –  Don’t Let the Bells and Whistles Distract You, Kiplinger.com, December 3, 2001
  • “Do you want proof positive that investors are irrational?  Here it is:  Sales of variable annuities went up 16% last year, to $85 billion.  A variable annuity is a mutual fund-type account wrapped in a thin veneer of insurance that renders the investment earnings tax-deferred.  The tax deferral is just about the only good thing you can say about these investment products.  Almost everything else about them is bad:  the high – sometimes outlandishly high – costs, the lack of liquidity, the fact that the annuity converts low-taxed capital gains into high-taxed ordinary income.  That tax deferral comes at a very high price.” – The Great Annuity Rip-Off, Forbes Magazine, December 6, 2001
  • “…[A]nnuities are actually a lot more complex and have downsides that salesmen may not mention.  The higher fees of most annuities can often cancel out their tax advantages; most annuities lock in investors for years; and annuities saddle heirs with higher taxes, unlike mutual funds or most other investments.  For these reasons, many investment experts say annuities are usually unsuitable for most older investors.” –  At Annuity University, Agents Learn How to Pitch to Seniors, Wall Street Journal, July 2, 2002
  • “The death benefit, which usually costs more than $1000 for a $100,000 account, isn’t going to help you if the market tumbles while you’re still alive.  Companies that guarantee your principal while you are alive often charge another $1000 a year on a $100,000 account.  Yet the chances of your benefiting are almost nil.” –  Why Variable Annuities Are Just For a Few, Kiplinger.com, March 30, 2003
  • “Many experts view variable annuities, a tax-deferred investment vehicle with an insurance contract, as inappropriate for elderly clients because of high fees and because the products’ tax benefits generally are realized only over decades.  Customers also pay steep ‘surrender’ fees for taking money out early.” –  State’s Annuity Investigation Widens, The Wall Street Journal, February 18, 2005
  • “Of course, I can’t blame my grandmother for not understanding what she bought.  These are complex insurance contracts larded with bells and whistles that make them enticing and expensive, and often misunderstood by the very people selling them.” –  An Annuity For Grandma?  Say It Isn’t So, The Wall Street Journal, March 6, 2005
  • As annuity sales practices come under greater scrutiny, the National Association of Securities Dealers is taking a closer look at its policy on sales contests, a common promotional tactic for the insurance product.  To encourage the sale of annuities, financial-services companies and insurers often offer salespeople financial rewards and other prized through contests.  As long as the contests are conducted within NASD guidelines, broker-dealers don’t have to disclose to their clients that they’re participating in a contest based on generating the most annuity sales.” –  NASD Rethinks Its Policy On Annuity Sales Practices, The Wall Street Journal, March 22, 2005
  • “The World’s Lousiest Estate Planning Vehicle – There’s no getting around the income tax due on annuities. In fact, if you die with money remaining in your annuity, your beneficiary will inherit all the taxes that you have deferred. Compare this to a mutual fund, whose basis is stepped-up at death. In that case, your beneficiary would owe no taxes on the gains.” –  What’s Wrong With Variable Annuities, SmartMoney.com, 2005
  • “Anytime anyone criticizes such shenanigans, annuity sellers rush to counter with claims that variable and fixed deferred annuities help retirees defer taxes and their heirs avoid probate.  Both claims are true.  But does that mean retirees should put their nest eggs in an annuity?  In general, no, say financial planners and independent insurance consultants.  And annuity experts at TIAA-CREF, the New York retirement-services company that created the variable annuity in 1952, agree. In short, the tax consequences and long holding periods necessary to make a variable annuity attractive don’t make sense for retirees. (Also, many annuities often pay big commissions to brokers, who often aren’t forthcoming about their financial interests.)” –  When Putting Your Nest Egg Into an Annuity Makes Sense, The Wall Street Journal, March 30, 2005
  • “Annuity sales can be highly lucrative.  Commissions can reach 12 percent of the money invested, far greater than fees typically generated on stocks and other investments.  Mr. Ragazzo, the deputy attorney general of California, said his office had found that some companies selling annuities sponsored trips to Hawaii and Europe for top agents.  ‘Some of these guys are former used-car salesmen bringing in $600,00 a year,’ he said.” – Who’s preying on Your Grandparents? The New York Times, May 15, 2005


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