“Variable Annuities” and “Equity Indexed Annuities” (sometimes referred to as “Indexed Annuities”) are complex, high-cost products that are usually unsuitable for most individuals, and especially seniors.
But billions of dollars of sales take place annually, encouraged by the high commissions paid to annuity sales people, who often fail to clearly explain the risks and pitfalls associated with such products.
Variable annuities are a tax deferred product that lets you invest in various subaccounts (mutual funds).
The annuity comes with an insurance contract, a death benefit that generally guarantees that a minimum amount will be paid to your beneficiaries should you pass before the annuity payments begin.
An equity indexed annuity is also a tax deferred product that generally guarantees a minimum interest rate (typically between 1% and 3%), which is tied to an equity index, typically the S&P 500.
Methods used to calculate the interest paid to you:
- Some equity indexed annuities will pay a “participation rate” of the gain of the index (for example 80% of the increase in the S&P over the course of a year);
- Some will subtract a fee from the index gain (for example, the investor will be paid the index gain minus 3.5%);
- Some have caps (for example, the rate might be capped at 5%, even though the index was up 8%).
Variable and equity indexed annuities pay very high commissions to insurance agents, stock brokers, and financial advisors, often resulting in abusive, misleading, and inappropriate sales to investors.
These financial tools are generally suitable only for those who can lock up their money for a substantial period of time (perhaps 10 years or longer), and also have used all available tax deferral options available to them.
Problems with variable annuities:
PENALTIES FOR WITHDRAWAL.
Most variable and equity indexed annuities impose “surrender fees,” which are penalties applied if you try to withdraw all of your money within the first 5 to 7 years. These fees typically decrease each year. For example, you might be charged a 7% surrender fee for a withdrawal during the 1st first year, 6% after the 2nd year, 5% after the 3rd year, until after the end of the 7th year there is no surrender charge.
These surrender charges make variable and equity indexed annuities unsuitable for those who need to preserve the liquidity of their investments, for current living expenses, medical or other emergencies, or other purposes.
However, many of these annuities allow you to withdraw a small portion of your money without penalty.
MISLEADING SALES PRESENTATIONS.
Variable and equity indexed annuities are often pitched to seniors through investment seminars promising “estate planning” or “tax planning.” However, these sales presentations are often misleading in a myriad of ways.
Rarely do these sales presentations reveal the substantial surrender penalties.
Some salesmen of variable annuities mislead investors with claims of guaranteed returns when, in fact, variable annuity returns are subject to the volatility of the stock market.
Also frequently omitted or glossed over in the sales pitches is the fact that the returns on equity index annuities do not include the dividends paid by the stocks in the index, which can sometimes be 2%-3%.
Some salesmen also improperly sell variable and equity indexed annuities to be placed inside an IRA or other tax deferred account. Since the IRA is already tax deferred, there is no additional benefit to the investor for doing so, though the salesmen will have earned a substantial commission on the sale.
INCOMPATIBLE FEES.
The average annual expense on variable and equity indexed annuity subaccounts (consisting of administration expenses, insurance expenses, subaccount expenses, annual fees, and other charges) is over 2% of assets. The average mutual fund, on the other hand, charges approximately 1.5%.
In addition, many variable annuities also have loads on their subaccounts (additional charges paid when the investment is purchased), and annual contract charges. These fees may not be appropriate for every investor.
HIGH TAXES.
Even though variable and equity indexed annuities grow tax deferred, when the investor takes distributions from the annuity, those distributions are taxed at ordinary income tax rates, which can be as high as 39.6% federal tax, plus possible state income tax.
For most investors, that is higher than the maximum 15% rate paid on long-term gains and dividend income earned in a taxable investment.
That difference can easily eat up the advantage of an annuity’s tax-free compounding.
If an annuity investor dies and the annuity balance is paid to a beneficiary, the beneficiary must pay ordinary income tax rates on any earnings beyond the original investment.
In contrast, other investments inherited by a beneficiary may enjoy a “stepped-up” basis, and if so, they would owe no taxes at the time of inheritance on money received.
ANNUITY SWITCHING DISADVANTAGE.
Some unscrupulous brokers suggest switching from one annuity to another in a “tax-fee” exchange. The broker earns another commission, and the holding period for the surrender penalties on the new annuity starts all over again.
If you have been sold a variable annuity or an equity indexed annuity that is unsuitable for you, you may have a basis for pursuing legal action to recover your damages.
Robert Port is a partner with Gaslowitz Frankel. Specializing in business litigation, Robert has extensive experience in contract and fiduciary disputes. To contact Robert directly to discuss your action plan, please click here.
Do you have questions about the issues surrounding annuities?
Gaslowitz Frankel LLC is Georgia’s premier fiduciary litigation law firm. The firm has earned a reputation for excellence across Georgia and the Southeast providing representation to individuals, executors, trustees, investors, shareholders, and financial institutions in complex fiduciary disputes involving wills, estates, trusts, guardianships, businesses, and securities. Contact us today at (404) 892-9797 or by e-mail at info@gaslowitzfrankel.com
