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March 20, 2007

Getting Out Of Variable Annuities

I recently did an online workshop titled "Why Annuities Stink." We wanted to use a bit stronger word than stink but people send me emails telling me they get offended when I use the word sucks. (It's a generational thing that I frankly don't get. It doesn't mean THAT anymore!)

 

After outlining the slew of problems with variable annuities, we went to the question and answer session where one of our Snider Investment Method alumni gave an account of a situation with her deceased Mother that illustrates some of the abusive sales practices that occur routinely with annuities.

 

Jane's mother died suddenly at Christmas. Just after the funeral, her financial advisor contacted Jane saying her Mother had an investment that needed to be "rolled-over." When the paperwork arrived, it turned out the investment was a variable annuity. Further investigation revealed this same advisor had sold her Mother another annuity just months before she died, with a long surrender period.

 

There are very few situations where a variable annuity makes sense and the older you are, the less sense they make. The only person who should have a variable annuity is a very young person, earning a very-high income, who has maxed out all other tax deferred alternatives, and knows they won't need the money for many years.

 

That is not the way they are sold - at all.

 

The North American Securities Administrators Association (NASAA) reported that between 2004 and 2005, 26% of the 3,635 state enforcement actions dealt with the financial exploitation of seniors; and 34% of all “successfully concluded enforcement actions” involved either variable or equity-indexed annuities. Patty Struck, administrator of the Division of Securities in Wisconsin, said last month that within the last year, 44% of the complaints securities regulators have received came from seniors.

 

Jane signed the contract rolling over the annuity based on what she said was pressure from the salesman "at a very bad time" when she was, obviously, distraught about her mother's passing and, I am guessing, not thinking real clearly. Notice I used the word salesman, not financial advisor or banker, even though this guy worked for one of the largest banks in the Southeast.

 

When Jane met with the estate attorney later that day about her Mother's estate, he told her they could have disclaimed the assets if she hadn't signed the contract. Jane is supposed to get a 15 day period in which she can change her mind. But when she called the advisor to tell him she no longer wanted to roll-over the annuity, he told her the contract had "already been Fed-Ex'd and it was too late!

 

So Jane's question was what to do with these annuities now that she was in them? This is a common question. I find that people experience buyer's remorse with variable annuities more than anything else. Not surprising since they are terrible investments.

 

There are three choices if you are in a variable or equity index annuity and want to get out. To understand the pros and cons of each, you must remember three things about these annuity contracts:

 

1. Variable annuities usually have a surrender fee that is gradually reduced over some period of time. Seven years is typical. Some go as long as ten. And the penalty is substantial. For example, a 7% charge might apply in the first year, 6% in the second year, 5% in the third year, and so on until the eighth year, when the surrender charge no longer applies.
2. Variable annuities are tax-deferred which means you are subject to a 10% early distribution tax if you take the money out before age 59 1/2.
3. The fees on variable annuities are very high. Those fees will eat up performance making them (did I already mention this?) terrible investments.

 

With those "gotcha's in mind, you have three choices for dealing with the "Hotel California" of investment products:

 

The first is to just wait until the surrender fee goes away. Often, contracts will allow you to withdraw part of your account value each year – 10% or 15% of your account value, for example – without paying a surrender charge. The pros of waiting are you avoid the surrender charge. The downside is you are stuck in a lousy investment because they have trapped you there. Generally not a good plan.

 

Second, is to do a 1035 exchange to a very low-cost, no bells and whistles annuity. This is basically an annuity roll-over. The steps are: 1) Pick a new annuity company - preferably a bare-bones, low cost one; 2. Contact that company for an application and 1035 exchange paperwork; 3) fill it out and they will take care of the roll-over.

 

There are several low-cost annuity providers including Fidelity and Vanguard. Unfortunately, one of the best no-load mutual funds, TIAA-CREF, has stopped accepting new investors. If you do a 1035 exchange, you are still liable for surrender charges with the old annuity but there will be no early withdrawal penalty if you are under 59 1/2 since you are rolling the money from one tax-deferred account to another. You also don't lose the tax-deferral. Be aware, the surrender charge clock will start all over again, though.

 

Your final option is to say "Screw it!", and cash it out. This is my preference. Yes. You are going to take the tax hit if you are under 59 1/2. Yes. You are going to pay a surrender charge. But I just don't believe in staying in a bad investment because they have trapped me in it. As far as I am concerned, you chalk that loss up to tuition and vow to yourself you'll never make that mistake again.

 

I think the real lesson here is not to buy a variable or equity indexed annuity in the first place. But if you do, you should know that you have options.

 

SOURCE: (direct quotes are indented and highlighted)

 

1. "Group Think." Investment Advisor March 2007.

http://www.investmentadvisor.com/magazine.php?issue=300075

 

2. "Variable Annuities: What You Should Know." United States Securities and Exchange Commission March 20, 2007.

http://www.sec.gov/investor/pubs/varannty.htm

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

 

Tags: 1035 exchange, equity index annuities, NASAA enforcement actions, SEC, Variable annuities

Posted by Kim Snider on March 20, 2007 | Permalink

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