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DebtFreeGuru.com's - Tip of the Week - Monday, June 14, 2004 |
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Confusion
as a Sales Tactic Learn
before you leap into variable annuities By
Christine Dugas – Last
month, securities industry regulators sanctioned brokerage firm David
Lerner Associates for running sales contests for variable annuities and
other investments. The
case serves as a reminder that broker-sold variable annuities can be
riddled with conflicts of interests. At
David Lerner, brokers got more points toward winning prizes like
big-screen TVs and trips to Las Vegas if they sold particular variable
annuities, according to the National Association of Securities Dealers (NASD),
an industry self regulatory group. The
brokerage firm, which neither admitted nor denied the charges, agreed to
pay $100,000 to settle allegations that the contests could taint their
recommendations. But David
Lerner isn’t the only firm to get into hot water over sales of variable
annuities. In the past two
years, variable annuity sales have been the subject of more than 80
disciplinary actions by the NASD. And
in January, an association of the states’ top securities regulators said
that unsuitable and misleading variable annuity sales practices were one
of this years top 10 investment scams. That
doesn’t mean that variable annuities aren’t legitimate products. But
they are sometimes sold to older investors and others for who they are not
suitable. Other sales abuses
are related to inappropriate variable annuity switches. “Contrary
to some representations, variable annuities are not a good choice for
everybody,” says Joe Borg, director of the Alabama Securities
Commission. If your broker is
pitching one to you, hopefully it’s because it’s in your best interest
and not because he’s making a big commission on sale or is hoping to win
a trip to Vegas. Unfortunately,
variable annuities are about as easy to understand as rocket science.
And brokers typically earn lucrative commissions from selling them,
creating the potential for high pressure sales tactics. So
it pays to learn the basics about them. And
if you’re thinking of buying one, you may want to get a second opinion
from someone who doesn’t have a vested interest in making the sale. The
ABCs of VAs Variable
annuities are a long-term retirement savings vehicle.
They are an insurance contract that combines a death benefit with
tax-deferred investments. There
is no limit as to how much you can put into a variable annuity. How
they work: You put after-tax
money into a variable annuity, allocating it among a menu of mutual fund
like investment options. Your
assets grow tax free until you start tapping your account. You
can move your assets among the investment options, and your return will
vary according to how the options fare.
If you withdraw the money before age 59 ˝, you’ll get hit with a
10% tax penalty on the amount you take out. At
retirement you can choose to get a lump sum payment or a guaranteed stream
of payments for as long as you live. If
you die before tapping the account, your heirs will receive the minimum of
the amount you originally contributed
– even if the investments have declined in value.
In some states variable annuity assets cannot be seized to pay
creditors or for legal judgments. All
of this comes at a cost. Investors
who cash in an annuity early usually pay a surrender charge on top of the
tax penalty. The charge
typically applies during the first five to seven years.
For instance, you may have to pay 7% on withdrawals the first year,
with the charge declining by 1% each year. In
addition, there are usually administrative charges, insurance charges,
investment management fees, and there can be other charges for special
options, such as enhanced death benefits.
The total annual expense ration can easily total 2.5%, experts say. Who
should buy a VA Because
of the investment risk and because of the length of time it can take for
the return on the investments to make up for the high fees, variable
annuities are generally not suited for older investors. They
are also not necessarily a good match for younger investors.
If you’ll need the money in the next few years for a down payment
on a home, then a variable annuity is not the place for your money, says
John Ganon, Vice President of Investor Education at the NASD. Before
you consider a variable annuity, make sure you have taken advantage of
less costly tax-deferred retirement savings options, especially those that
allow you to invest pretax dollars, such as a 401(k) or a deductible IRA. If
you have contributed the maximum to those options, and still have
retirement money to stash away for at least 20 to 15 years, then you may
want to consider a variable annuity. But
even then, the high fees may outweigh the value. On
balance, you may do better buying a mutual fund it you’re looking to
invest your money and buying a separate term insurance policy if you want
life insurance, says Tom Grzymala, a financial planner in Alexandria, VA. If
you’re still interested in a variable annuity, look for a low-cost
annuity from a reputable insurance company.
A number of variable annuities are offered through no-load mutual
fund companies such as Vanguard, TIAA_CREF, Fidelity and T. Rowe Price.
Their annual expense are lower than average, and they may not
impose surrender charges. There’s
another factor to consider. The
lower tax rates for capital gains and dividend income have altered the
relative merits of tax-deferred accounts, which are taxed as ordinary
income. That’s especially
true of accounts that are funded with after tax dollars, like an annuity. An
analysis by mutual fund company T. Rowe Price found that assuming the same
investment return, it takes much longer – up to 25 years – for a
tax-deferred account to match the after-tax returns on an investment that
is taxed as capital gains or dividend income. Of
course tax rates on dividends and capital gains may go up in the future.
And some people like the idea of putting cash into an account that
can’t be tapped until you reach retirement age.
So if you’re considering a variable annuity check out the NASD
investor alert “Variable Annuities: Beyond the Hard Sell.”
It’s available on the NASD web site at www.nasd.com. |
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