- March 8, 2021
Variable annuities are essentially mutual funds packaged and marketed as insurance products. While they may be appropriate for some investors, the potential benefits may not outweigh the risks. These investments are popular because policyholders don’t typically pay taxes on their earnings right away, their beneficiaries receive a death benefit, and withdrawals can stand in for income in advanced years. But some investors may be persuaded to buy an annuity when it’s not in their best financial interests; it’s so common that the Financial Industry Regulatory Authority (FINRA) has issued an education advisory to help consumers better understand the potential risks.
How Variable Annuities Work and the Major Caveats
Investors pay regular premiums into dedicated investment accounts over years–sometimes decades; distributions may be made as a lump sum payment or released in small amounts over time, although typically not before age 59 and ½. It seems like a wise move–pay money into an account now to withdraw it later when you want to retire. These annuities work like mutual funds, where many investors’ funds are pooled and then invested in stocks, bonds, and other securities and managed for the benefit of the group by a member firm.
However, there are serious concerns with this securities product. Because these annuities’ performance is tied to the stock market, their growth may be uneven and, in the end, insufficient for the investors’ needs. In fact, the rate of return isn’t even guaranteed, and required fees generally increase yearly. So policyholders can make payments month after month not see the value of their account grow at the same pace. If the stock market plummets, it can even wipe out the full value of the annuity.
Tax Concerns Loom Large
While many investors are aware that early withdrawals mean taxes and penalties, they may not realize that it’s a 10% tax plus additional taxes on the money gained through investment activity, which can add up quickly. Investors lose out too, because unlike other investment options like 401ks, the money that’s used to fund an annuity isn’t tax-deferred to reduce your overall tax liability at the end of the year. And when investors do begin drawing from their annuity, any earnings are taxed as income, not capital gains, which is generally less.
Nickels and Dimes Add Up
Investors may also end up paying far more than they budgeted for. Many of the annuity products have fees attached that add up quickly in ways investors don’t even realize. For example, the fees investors pay for their annuity can include insurance costs to cover death benefits and guaranteed income promises, administrative fees, and any add-ons like long-term health insurance coverage. These expenses often increase annually, too, requiring investors to pay more every year for a benefit that doesn’t also increase.
Too Good to Be True?
The biggest threats to investors as a result of purchasing a deferred variable annuity are having money tied up for a long time, the cost of withdrawing funds early if necessary, excessive and increasing fees for maintenance costs and added services, and the volatility inherent in the stock market. And because these variable annuities are market-based, brokers selling this kind of securities product must still adhere to FINRA suitability rules and ensure that it truly is an effective way to meet the financial objectives of the investor, given the investor’s tolerance for risk and tax liabilities.
Many variable annuities have terms and conditions that can interfere with investors’ goals. There are often high fees to participate, and if a policyholder wants to withdraw funds early, the high taxes and penalties can be steep. Given the potentially misleading marketing approaches as well, some investors may not fully realize the risks they’re taking by purchasing a variable annuity. That’s why it’s so important for investors to carefully consider their short- and long-term goals in light of any variable annuity prospectus they’re considering. For investors who feel their annuity has not been handled ethically or legally, FINRA’s Investor Complaint Center can help.
The Wolper Law Firm, P.A. represents investors nationwide in securities litigation and arbitration on a contingency fee basis. Matt Wolper, the Managing Principal of the Wolper Law Firm, P.A., is a trial lawyer who has handled hundreds of securities cases during his career involving a wide range of products, strategies and securities. Prior to representing investors, he was a partner with a national law firm, where he represented some of the largest banks and brokerage firms in the world in securities matters. We can be reached at 800.931.8452 or by email at firstname.lastname@example.org.