Beware of the annuity salesman's scare tactics

High fees, more risk? Here's why you should be skeptical of an insurance salesman's pressures to buy a variable annuity.

Article by Liz Pulliam Weston of MSN Money. Original direct url is http://articles.moneycentral.msn.com/Insurance/AvoidRipoffs/BewareOfTheAnnuitySalesmansScareTactics.aspx

High fees, more risk? Here's why you should be skeptical of an insurance

High fees, more risk? Here's why you should be skeptical of an insurance salesman's pressures to buy a variable annuity

Regulators have been cracking down on the sale of variable annuities in recent years, charging some insurers and brokerages with questionable sales practices. Just a few years ago, the National Association of Securities Dealers (NASD) 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 NASD 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 NASD still filed 88 separate complaints against companies in 2005, many of which ended 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, then take the money out to spend in retirement.

Annuities also can either 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.

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 lower your tax rates, the less attractive a variable annuity should be.

The insurance feature means that variable annuities cost more than comparable mutual fund investments. It takes awhile -- 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, since 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.

All this makes variable annuities inappropriate for short-term investors, people who won't live long enough for the benefits to outweigh the costs and those who need immediate income. Because annuities can offer juicy commissions, though, some salespeople push them regardless of whether they're good for their clients, as illustrated by recent NASD enforcement actions:

A Banc of America Investment Services employee was charged with selling an unsuitable annuity to an 18-year-old. The teenager had received a small inheritance and planned to use the money after college as a home down payment. She was in too low a tax bracket to benefit from any tax deferral and had no need for the death benefit, since she was single and had no dependents. To make matters worse, the NASD says, the broker put all the client's money in a single equity investment sub-account, exposing her to much higher risk than was suitable.

An Edward Jones employee was charged with an unsuitable sales transaction for selling a deferred variable annuity to a client who needed current income and who didn't need tax deferral or the death benefit. The NASD says the client was convinced to liquidate $60,000 of a $250,000 portfolio to buy the annuity, only to find her investments no longer generated enough income for her to live on. She wound up having to make $360-a-month withdrawals from the annuity just to make ends meet,
A Raymond James and Associates representative allegedly convinced a client to exchange an annuity she'd owned for six years for another. He reaped a higher commission, but the annuity cost her a $1,600 surrender penalty -- and left her with an investment with much higher expenses. Had she kept her original annuity for just 8 more months, she could have accessed her money with no penalty. The new annuity had a much longer surrender-penalty period of nine years.

If you think you or someone you love has been sold an unsuitable annuity, you can contact the SEC or the NASD for help. These regulators also offer advice for those considering an annuity, such as the NASD online booklet "Variable Annuities: Beyond the Hard Sell".

If you're still interested in a variable annuity for retirement savings, here's how to make sure it's the right option:

Don't buy an annuity that will be held in an IRA or 401(k). An annuity's main benefit is tax deferral, and you've already got that in an IRA or 401(k). If you're attracted by the death benefit, buy life insurance instead to ensure your family will have enough money if you die.
Don't buy an annuity until you've exhausted other retirement savings vehicles. You shouldn't consider a variable annuity until you've contributed the maximum to your 401(k) and have fully funded your traditional or Roth IRA for the year.
Make sure this isn't money that will be inherited. Annuities, unlike most other investments, don't get a special tax treatment known as a "step up" in basis when you die. This step-up can eliminate taxes on stocks, bonds, mutual funds and real estate that are inherited, but your heirs will owe income taxes if they inherit an annuity.
If you're worried about lawsuits, consider alternatives. There are usually other, cheaper ways to protect your assets, such as buying an umbrella liability insurance policy.
Be confident you're in it for the long haul. Analysts at T. Rowe Price figure you need to own a low-cost annuity for at least 10 years for the higher expenses to be outweighed by the tax benefits. The higher the annuity's cost, the longer you'll need to own it. Which leads to:
Shop around. Vanguard, TIAA-CREF, T. Rowe Price and Fidelity are among the companies that offer lower-cost annuities.