A variable annuity is an insurance product sold for investment purposes. The insurance element is the death benefit which is payable only if you die at the time the variable annuity is still in effect. To receive the death benefit you have to die- an event many investors do not appreciate! The investment element is the market risk of the annuity owner in selecting the mutual funds offered for investment within the annuity.
While variable annuities marketed by different insurance companies have different bells and whistles, all variable annuities have certain basic features. Below I describe the five common flaws of which brokers either intentionally fail to inform you or, more commonly, are not acquainted with themselves.
1. All variable annuities have extremely high costs and commissions which, for the most part, are hidden. The biggest cost is in the form of surrender fees which in reality are the recoupment of the sales commission. The broker often takes the commission in a lump sum, closes his file and mines for other potential victims but the insurance company that provides the annuity recovers the commission over many years. There are additional charges for the death benefit, the administration of the annuity, and the management of the mutual funds. Cumulative costs make variable annuities an extremely expensive commission driven product. Although the owner of the annuity needs financial advice for many years, most brokers are gone shortly after the product is sold.
2. In theory, all variable annuities have two phases. First is the accumulation phase when the annuity is supposed to be growing tax deferred. The second phase is when the annuity owner decides to annuitize the variable annuity. In exchange for the investment, the insurance company sends a fixed monthly check for the owner’s life. Annuitization is the only purpose of buying a variable annuity. In reality only less than 5% of variable annuities are ever annuitized. In other words, almost all variable annuities fail. For this reason alone variable annuities are not suitable for the vast majority of people, especially older people.
3. All promoters talk about the tax deferred characteristics – except those promoters who sell variable annuities to people who already have an IRA account. Those promoters fail to mention the tax deferred status of variable annuities because no tax advantage exists when a variable annuity is funded through an IRA.
4. Although variable annuities are tax deferred promoters fail to point out that any withdrawals are taxed at income tax rates in lieu of much lower capital tax rates. Studies comparing after-tax returns on investments in securities to variable annuities have shown that there is little or no tax advantage of variable annuities after about 10 years.
5. The variable annuity industry is virtually unregulated because states consider a variable annuity to be an insurance product and state insurance departments are not equipped to deal with the investment aspect of variable annuities. As a result, after the variable annuity fails, the only remedy left for you is litigation thru FINRA.
In sum, if you want life insurance talk to a life insurance agent. If you want investment advice talk to a reputable investment advisor. Marrying the two together results in the worst marriage known to the financial world and results in more fiscal divorces than anything I’ve seen in almost 20 years. Ultimately your only recourse may be to recoup a portion of your loss through the services of an attorney who specializes in securities arbitration.