The Securities and Exchange Commission issued an on-line brochure on variable annuities yesterday which contains many warnings and cautions to investors concerning these fashionable products, which have their uses but can be oversold, and are often difficult for investors to understand due to their complexity.
Variable annuities have attractive features such as lifelong payments and death benefits, but they also have some pitfalls which salesmen often don't reveal to investors, said the SEC.
On the same day, Paul Roye, director of the SEC's Investment Management Division, told a meeting of the National Association for Variable Annuities that SEC inspectors have been gathering information on sales of variable annuities from brokerage firms and financial advisers around the country with an eye to possible sanctions. 'I would urge you not to wait for our inspectors to come knocking on your door with questions about bonus products.' said Roye.
Sales of variable annuities by insurance companies, brokerage firms and other financial institutions reached $120 billion in 1999. Variable annuities are bought with one or a series of payments, and deliver a future stream of payments which vary according to the performance of the underlying investments, which are often mutual funds. The annuity is tax-deferred, in that gains in the underlying investments are not taxed until money is paid out. The SEC points out that anyone with an existing 401k plan will not get any additional tax benefits from a variable annuity, and that a variable annuity is unlikely ever to be preferable to a 401k plan, until the limits of the 401k have been reached.
The SEC's brochure contains a number of specific warnings:
"Remember: Variable annuities are designed to be long-term investments, to meet retirement and other long-range goals. Variable annuities are not suitable for meeting short-term goals because substantial taxes and insurance company charges may apply if you withdraw your money early. Variable annuities also involve investment risks, just as mutual funds do.
"You will pay for each benefit provided by your variable annuity. Be sure you understand the charges. Carefully consider whether you need the benefit. If you do, consider whether you can buy the benefit more cheaply as part of the variable annuity or separately (e.g., through a long-term care insurance policy).
"If you are thinking about a 1035 exchange, you should compare both annuities carefully. Unless you plan to hold the new annuity for a significant amount of time, you may be better off keeping the old annuity because the new annuity typically will impose a new surrender charge period. Also, if you decide to do a 1035 exchange, you should talk to your financial professional or tax adviser to make sure the exchange will be tax-free. If you surrender the old annuity for cash and then buy a new annuity, you will have to pay tax on the surrender.
"Variable annuities with bonus credits may carry a downside, however – higher expenses that can outweigh the benefit of the bonus credit offered.
"If you already own a variable annuity and are thinking of exchanging it for a different annuity with a bonus feature, you should be careful. Even if the surrender period on your current annuity contract has expired, a new surrender period generally will begin when you exchange that contract for a new one. This means that, by exchanging your contract, you will forfeit your ability to withdraw money from your account without incurring substantial surrender charges. And as described above, the schedule of surrender charges and other fees may be higher on the variable annuity with the bonus credit than they were on the annuity that you exchanged."
The SEC gives a list of questions which the average investor should ask himself before investing in a variable annuity:
Are you investing in the variable annuity through a retirement plan or IRA (which would mean that you are not receiving any additional tax-deferral benefit from the variable annuity)?
Are you willing to take the risk that your account value may decrease if the underlying mutual fund investments perform badly?
Do you understand the features of the variable annuity?
Do you understand all of the fees and expenses that the variable annuity charges?
Do you intend to remain in the variable annuity long enough to avoid paying any surrender charges if you have to withdraw money?
If a variable annuity offers a bonus credit, will the bonus outweigh any higher fees and charges that the product may charge?
Are there features of the variable annuity, such as long-term care insurance, that you could purchase more cheaply separately?
Have you consulted with a tax adviser and considered all the tax consequences of purchasing an annuity, including the effect of annuity payments on your tax status in retirement?
If you are exchanging one annuity for another one, do the benefits of the exchange outweigh the costs, such as any surrender charges you will have to pay if you withdraw your money before the end of the surrender charge period for the new annuity?
Remember: Before purchasing a variable annuity, you owe it to yourself to learn as much as possible about how they work, the benefits they provide, and the charges you will pay.
On the Net: The brochure ``Variable Annuities: What You Should Know'' is available on the SEC's Web site at http://www.sec.gov/consumer/varannty.htm
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