Making Your Money Last
The Great Annuity Rip-Off
Unscrupulous agents take advantage of seniors with risky investments that cost too much.
By Kimberly Lankford, Contributing Editor
From Kiplinger's Personal Finance magazine, January 2007
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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.
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.
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.
