By Chad M. Kohler, Esq.
"A guaranteed income for life" sounds like a pretty good proposition
to most investors.
When I was a stockbroker, I heard countless sales pitches from variable
annuity wholesalers who would come into my branch office and tout promises
of "guaranteed lifetime income" as the reason why a variable
annuity should be part of practically every investor's portfolio.
These promises prove enticing for many investors.
At the end of 2013, the total amount U.S. investors had placed in variable
annuities was an astounding $1.8 trillion.
Smooth sales pitches aside, variable annuity contracts are often riddled
with opaque terms and conditions, high annual fees, hefty surrender charges,
and illusory tax benefits. Many investors find out too late that that
they would have been much better served if their financial advisor had
steered them toward other, more transparent, lower-cost investment alternatives.
Some investors are fighting back. Data from the Financial Industry Regulatory
Authority (FINRA) shows a substantial spike in customer complaints relating
to variable annuities, according to
The Wall Street Journal. FINRA regulates brokerage firms and oversees the mandatory arbitration
process through which most customer disputes are decided. The cases at
our investment fraud law firm reflect this increase in claims relating
to variable annuities.
In my experience, the typical customer purchasing a variable annuity really
has no idea what they're actually buying. Sadly, the broker selling
the variable annuity often doesn't understand the product much better.
The Securities & Exchange Commission (SEC) recently issued an Investor
Bulletin, "Variable Annuities – An Introduction." It serves as a useful primer for investors who are considering
buying a variable annuity.
Here are some basic facts about variable annuities that every investor
needs to consider.
Variable Annuities Are Complicated Investment Products
If your financial advisor is pitching a variable annuity, there's a
good chance you've been given a glossy brochure with pictures of happy-faced
retirees enjoying their golden years. The brochure may look nice, but
it probably provides only a cursory explanation of the variable annuity
that is being sold.
With clever marketing, it's easy to be lulled into thinking that a
variable annuity provides a safe, simple solution for your retirement
income needs. Don't be fooled: variable annuities are incredibly complicated
At its most basic level, a variable annuity is a contract between an investor
and an insurance company in which the insurance company agrees to make
periodic payments to the investor. The payments may begin right away (an
immediate annuity) or at some later time (a deferred annuity). What makes
variable is that the value of the annuity (including future periodic payments)
will vary depending upon how investments inside the annuity perform. These
investments are typically
mutual funds that are tied to stocks, bonds, and cash equivalents, or some combination
of the three.
By far the most confusing part for most investors (and most brokers, if
they're being honest) is grappling with the intricacies of various
riders that promise guaranteed "living benefits" with minimum
"roll ups" and periodic "step ups." There are a lot
of moving parts to these contracts, and they "continue to get more
complex," as Richard Ketchum, FINRA Chairman and CEO, recently told
The Wall Street Journal.
Investors are often caught off guard by what is buried in the fine print.
Money Magazine, many investors have been surprised recently to learn about contract terms
allowing the insurance company to hike fees and restrict investment options.
The bottom line: before you buy a variable annuity, make sure you understand
how it works. The best way to do this is to carefully read the variable
annuity prospectus, which describes the annuity's features in detail.
Don't be afraid to ask your financial advisor questions, and if you're
in doubt, get a second opinion.
Variable Annuities Are Often Expensive and Not Worth the Costs
There's no such thing as a free lunch, and the bells and whistles that
are part of most variable annuity contracts come with a hefty price. When
you start adding it all up, the expenses can easily bite off 3% or more
of your account value per year. This means you need to achieve an annual
return of 3% just to break even. Put another way, if the investments inside
your variable annuity grow by 5% annually, then the return that your annuity
is actually credited after expenses is a meager 2%.
I've talked to many investors who can't understand why their variable
annuities have remained stagnant in recent years even as the stock market
has done well. More often than not, the culprit is the hefty expenses
the investor is paying. In many cases the investor finds that they would
have been better off sticking with a traditional investment account holding
a diversified mix of equities and
In addition to annual expenses, investors also need to be aware of surrender
penalties, which apply to withdrawals made within a specified time period
after the annuity is purchased. The penalty period is usually six to eight
years, but some contracts go out 10 years or more. The penalty assessed
is a percentage of the amount withdrawn and generally declines over time.
For example, a 7% surrender penalty might apply to withdrawals made in
the first contract year, 6% in the second year, and so on. For investors
who tie up all of their assets in a variable annuity and find themselves
cash-strapped only a few years into the contract, surrender penalties
can take a heavy toll.
Tax Deferral Is Rarely a Justification for Purchasing a Variable Annuity
An often hyped benefit of a variable annuity is tax deferral. Tax deferral
means that the investments inside the annuity grow tax free and taxes
on gains are paid only as money is withdrawn. But other investment vehicles
(most notably IRAs and 401(k) plans) already offer tax-deferred growth.
For most investors who are not yet retired, it makes no sense at all to
invest in a variable annuity unless you are already maxing out the allowable
contributions to all of your retirement accounts.
Even then, the supposed tax-deferral benefits of a variable annuity might
be misleading. This is because investment gains in a variable annuity
are taxed at your highest marginal income tax rate. By contrast, investment
gains in a traditional brokerage account are taxed at the lower capital
gains tax rate. According to a study cited by
Forbes, even individuals in a 36% marginal tax bracket "will never come out ahead by investing in a variable annuity due to the prolonged drag of fees and tax issues."
Moreover, for retirees who are considering investing in a variable annuity
in their IRAs or other qualified retirement plans, it is important to
understand that the variable annuity will not provide any additional tax
benefits. For these investors, a variable annuity only makes sense if
the annuity's other benefits, such as lifetime income payments, are
worth the cost. As noted above, for many investors, the costs outweigh
About Meyer Wilson
The team of investment fraud attorneys at Meyer Wilson has successfully
represented nearly 1,000 individual investors from across the country
who have suffered financial harm at the hands of stockbrokers, brokerage
firms and insurance companies. We have won verdicts, arbitration awards
and settlements of hundreds of millions of dollars for our clients. If
you believe you have a case involving investment misconduct our firm can
help. Meyer Wilson represents clients nationwide from offices in Ohio