Beware of the annuity salesman's scare tactics

By Liz Pulliam Weston

Regulators have been cracking down on the sale of variable annuities in recent years, charging some insurers and brokerages with questionable sales practices. For example, the Financial Industry Regulatory Authority (then the National Association of Securities Dealers) accused several companies of frightening elderly customers into buying high-cost, high-risk annuities to protect their assets.

The annuity sellers were exaggerating the risks that the elderly could lose their assets because of lawsuits or seizures by creditors, said officials, and downplaying or concealing the disadvantages of annuities that make them inappropriate investments for elderly investors.

(Money in retirement accounts, including annuities, can be safe from seizure in bankruptcy or as damages in a lawsuit, depending on state law.)

Insurers say they've beefed up their supervision of annuity sales, but dozens of complaints against companies are still filed each year. Many end with steep fines and suspension of business.

If you're not familiar with annuities, they come in two basic flavors, deferred and immediate:

• Immediate annuities begin paying out income as soon as you buy them, typically for life.

• Deferred annuities are designed as retirement-savings vehicles. You put the money in now, watch it grow (one hopes) over time, and then take the money out to spend in retirement.

Annuities also can be fixed or variable. Fixed annuities earn a set return. With a variable annuity, your returns depend on the performance of stock, bond or cash investments you choose.

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Most regulatory attention is focused on deferred variable annuities. Think of these as a combination of an insurance contract and an investment in which your gains can grow tax-deferred. The insurance part guarantees that, if you die, your heirs will receive at least as much as you originally invested. Annuities also can protect your assets from lawsuits and creditors.

Sounds good, yes? Unfortunately, there are no free lunches in investing.

• Tax deferral has a downside. Your gains aren't taxed until you withdraw the money, but then you pay at regular income tax rates, which currently range up to 35%. If you held comparable investments in mutual funds or stocks for at least a year, you would pay capital gains tax rates of 5% to 15%. The higher your tax bracket, the less attractive a variable annuity should be.

• The insurance feature means that variable annuities cost more than comparable mutual-fund investments. It takes a while -- 10 years or longer -- for the benefits of the tax deferral to overcome the extra costs.

• In addition, variable annuities typically come with surrender charges and penalties designed to give you an incentive to leave your money alone. And, because they're considered retirement investments, any withdrawal you make before age 59 1/2 is subject to a 10% federal penalty on top of any income tax you owe.

Continued: Don’t buy until you've exhausted other alternatives

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