Unscrupulous agents take advantage of seniors with risky investments that cost too much. By Kimberly Lankford, Contributing Editor December 31, 2007 Seven years ago, when Alice Bouchard was 85 and needed her money to be easily accessible, an insurance agent sold her a deferred annuity that tied up her money until she was 101. If she had needed to withdraw the money during the first five years after buying the annuity, she would have paid a massive 25% surrender charge.And if that weren't bad enough, the agent paid Bouchard regular annual visits and persuaded her to sell the annuities she had purchased in past years and buy new ones. Each time, she had to pay surrender charges. Then, she says, without her knowledge the agent began shifting money to other family members after she reached 90 (the maximum age at which you can buy an annuity from most companies). RELATED LINKS Dump a Bad Annuity Guarantee Income in Retirement Bouchard, who lives in New Port Richey, Fla., and her daughter, Sister Carole Bouchard, a member of the Society of Sisters for the Church, eventually sought the advice of a financial planner, who contacted the Florida Department of Financial Services. Investigators discovered that Bouchard had paid more than $6,500 in surrender charges and taxes, and she had lost ownership of $293,000 that had been transferred to various members of her family. The agent had cleared $138,000 in commissions. The agent preyed on Bouchard's fear of losing money by promising that she'd get the benefits of investing without the risk -- a typical ploy of salespeople who push unsuitable annuities, regulators say. And it's a ploy that seniors and people nearing retirement will encounter more frequently. As the tidal wave of baby-boomers begin to leave their jobs, taking with them hefty balances in their 401(k)s and IRAs, sales of annuity products will increase -- and so will the unscrupulous sales tactics that often accompany them. Advertisement Surrender charges on deferred annuities can cost investors 10% or more if they withdraw money or switch policies within the first few years. The charges decrease gradually over time, but they can remain for ten years or more -- and be in effect at exactly the time when seniors can't afford to tie up the money they need for living expenses or medical bills. "In general, these annuities are not a good product for older citizens," says William Galvin, secretary of the Commonwealth of Massachusetts. Galvin's office fined one bank $3 million for dishonest conduct in selling deferred annuities to seniors. It also required two banks to offer refunds to elderly customers. But the longer the surrender period, the higher the commission, so agents have a big incentive for selling deferred annuities. Agents can earn as much as 4% to 7% up front, and as much as 5% to 12% on a specific type of annuity called an equity-indexed annuity. When a $500,000 IRA rollover can earn an agent an immediate commission of $60,000, it's easy to understand what motivates a hard sell. In 2005, the North American Securities Administrators Association, the trade group for state securities regulators, cited dishonest annuity sales practices as one of the top ten threats to investors. The main problem, regulators say, isn't necessarily the product itself but the way it's sold. Agents often don't explain investment risk, fees or surrender charges. Even more egregious are cases in which agents have forged signatures, withheld key disclosure forms and lied about fees and potential returns. And, as in Bouchard's case, some agents churn clients' accounts -- moving money from one annuity to another while earning an additional commission each time. The industry concedes that "there have been abuses in which annuities were recommended when they weren't appropriate," says Michael DeGeorge, vice-president and general counsel for the National Association for Variable Annuities. He says his group is committed to matching annuities with the right buyers. "An inappropriate sale can taint the entire industry," says DeGeorge. Advertisement How they work To spot the problems, you have to know the basics of how annuities work. For starters, they come in two varieties: Immediate-income annuities provide income right away; deferred annuities allow investors to save for retirement while deferring taxes. With an immediate-income annuity, you give an insurance company a chunk of money in exchange for the insurer's promise to send you regular payments for the rest of your life, or for a certain period of time. Immediate annuities can be an appropriate and simple way to invest some of your nest egg while you're in retirement. Deferred annuities, on the other hand, are complex investment products. Besides surrender charges, some charge annual fees that can top 2%, plus the management charges of the underlying investments. The most common type of deferred annuity is the variable annuity, which lets you choose from among several mutual fundÐlike accounts. The value of your accounts rises or falls with the performance of those funds. An equity-indexed annuity is an exotic variation of deferred annuity that ties returns to stock-market indexes. Advertisement A deferred annuity offers tax benefits similar to those of a traditional nondeductible IRA. You don't owe taxes until you begin making withdrawals, which are then taxed as ordinary income. Deferred annuities became much less appealing when the tax rate on capital gains dropped to 15% (or lower) in 2003, making it more attractive, tax-wise, to simply invest in stocks and mutual funds. Shift in tactics As a result, annuities salespeople switched tactics, focusing on guarantees instead of tax savings. For example, a guarantee in an annuity contract might promise that your account balance will never fall below a certain level, no matter how poorly the stock market performs, or it might promise to give you a minimum annual payout. But figuring out which guarantees are worthwhile is extremely complicated. Mark Cortazzo, a certified financial planner in Parsippany, N.J., specializes in clients who are nearing retirement or are recently retired. He avoids most of the deferred annuities on the market, and rarely recommends them to people in their seventies or eighties. "Out of 100 annuity contracts, fewer than a dozen work well," says Cortazzo, who says his staff spends thousands of hours each year poring over contracts to find the few that provide good value. The ideal candidate for a deferred annuity, says Cortazzo, is someone between the ages of 55 and 65 who needs to have immediate access to the investment but still wants the option of a guaranteed income later. Cortazzo likes contracts that, for example, let you withdraw 6% of your original investment every year until you decide to convert the investment to a lifetime string of payments. Regardless of market performance, those payments will be based on no less than the value of your original investment. Advertisement But most contracts aren't that generous. They may guarantee nothing more than a death benefit rather than a certain amount of lifetime income -- a fact many buyers don't realize. Equity-indexed annuities can be even more complex. "They're sold as the best of both worlds, with no risk on the downside and all the profit on the upside," says Barry Lanier, chief of the Bureau of Investigation for the Florida Department of Financial Services. "But the upside is never that good." Most equity-indexed annuities don't count dividends, and annual returns are either limited to a percentage of the stock market's gain -- for example, 80% -- or capped at, say, 8% per year. To compound the problem, equity-indexed annuities fall into a gray area and are not regulated as securities. Salespeople who push them don't have to be licensed to sell securities and may not know about other investing options. And here's the best-kept secret in the annuities business: There's no reason for you to pay high up-front commissions or get stuck with a long surrender period. Most companies offer identical annuities with lower commissions and shorter surrender periods -- if you're savvy enough to ask. The ones Cortazzo recommends are those that carry a commission of 1.5% to 2% the first year, followed by 1% annually, and have a relatively short surrender period of three years or less. Outrageous returns But even a good deferred annuity isn't suitable for most people. Younger individuals should invest first in 401(k)s and IRAs, and then in taxable accounts; older people like Alice Bouchard should stick with immediate-income annuities. To persuade seniors to buy deferred annuities, "salespeople use any argument that appears to be effective," says Galvin. Sometimes agents pitch annuities as estate-planning tools, even if the death benefit is paltry. And some agents promise outrageous returns. In one extreme case, an agent persuaded 32 Exxon employees from Louisiana to retire early, take their retirement money in a lump sum and invest it in deferred variable annuities. The agent promised they could replace all of their monthly income by earning up to 18% a year. If he couldn't produce returns of 10% to 14% a year, the agent said, his clients could fire him. Most of the employees didn't understand that they were investing in annuities, says their lawyer, James Swanson. Nor did they realize they were paying close to 3% per year in expenses and that the agent was investing their money in ultra-risky mutual funds with no guarantees to protect them. His clients were "slaughtered," says Swanson. "These people started with $600,000 or $700,000 in 2000, and by 2002 they had $200,000." NASD charged the broker with securities fraud and last fall fined his broker-dealer, Securities America, $2.5 million for inadequate supervision. The company has also paid investors $13.8 million in restitution. However, it is appealing $9 million in punitive damages and lawyers' fees, according to a spokesman. No free lunch Seniors are particularly vulnerable at "free lunch" seminars where agents feed them the hard sell. Michael Huggs, a senior examiner for the Mississippi Secretary of State's office of business regulation and enforcement, recently interviewed an agent who referred to seniors attending these free-lunch seminars as "plate lickers" -- a phrase that even appears in some agent-training materials. "If you have that much disdain for your clients, you shouldn't be in this business," says Huggs. And disdainful is one way to describe the treatment of Alice Bouchard, now 92, and others like her. Florida investigators identified three other individuals allegedly ripped off by the same agent, Bijan Razdar. Razdar was permanently banned from the insurance business in Florida, but was arrested last October for conducting business without a license and is awaiting trial. Razdar denies doing anything wrong. He says surrender charges were irrelevant because his clients wanted the annuities for their death benefit. But Bouchard says she told Razdar repeatedly that she didn't want to lock up her money for more than five years. And Lanier, the Florida official, points out that her beneficiaries would have inherited about as much if she had simply put the money in a CD. Razdar says he was advised to settle the cases by his insurance company, and that he couldn't afford to continue fighting the state. He also says he is contesting the charge that he was conducting insurance business without a license. Bouchard settled with Razdar in September for an undisclosed amount. Most of those to whom he sold annuities have gotten part of their money back from him through civil suits or by working with the insurance companies to cancel any penalties. Some of the victims are suing the insurers to get back more of their money.