Tuesday, August 6, 2013

FINRA Warns and Informs About Variable Annuities

If you’re nearing retirement, then you’ve most likely been approached about purchasing a variable annuity. Are these products a good fit for you as you build and protect your retirement nest egg? At Net Worth Advisory Group, we feel there are some circumstances where certain annuities may add value to a client’s portfolio. However, more commonly annuities aren’t recommended because there are likely superior alternatives.  

The Financial Industry Regulatory Authority (FINRA) published an investor alert to help educate investors about these confusing products and suggest questions to ask and aspects to consider when considering the purchase of an annuity. The following information is taken from that article:

The variety of features offered by variable annuity products can be confusing. For this reason, it can be difficult for investors to understand what’s being recommended for them to buy --especially when facing a hard-charging salesperson. Before you consider purchasing a variable annuity, make sure you fully understand the following seven factors:
  1. Liquidity and Early Withdrawals: Many variable annuities assess surrender charges for withdrawals within a specified period, which can be as long as 6 to 10 years. Also, any withdrawals before an investor reaches the age of 59 ½ are generally subject to a 10% penalty in addition to any gain being taxed as ordinary income.
  2. Sales and Surrender Charges: Most variable annuities have a sales charge. These charges normally decline and eventually are eliminated the longer you hold the annuity.
  3. Fees and Expenses: In addition to sales and surrender charges, variable annuities may impose a variety of annual fees and expenses, such as:
    • Mortality and expense risk charges
    • Administrative fees
    • Underlying fund expenses
    • Charges for special features or riders
  4. Taxes: While earnings in a variable annuity accrue on a tax deferred basis - typically a big selling point - they do not provide all the tax advantages of 401(k)s, IRAs,  and other before-tax retirement plans. 401(k)s and other before-tax retirement plans not only allow you to defer taxes on income and investment gains, but allow your contributions to reduce your current taxable income. Once you start withdrawing money from your variable annuity, earnings (but not principal) will be taxed as ordinary income rather than at favorable capital gains tax rates.
  5. Bonus Credits: In an attempt to attract investors, many variable annuities offer bonus credits that can add a specified percentage to the amount invested in the variable annuity, generally ranging from 1-5 percent. Bonus credits are usually not free. In order to fund them, insurance companies typically impose high mortality and expense charges and lengthy surrender charge periods.
  6. Guarantees: Insurance companies issuing variable annuities provide a number of specific guarantees. These guarantees are incredibly complex and only as good as the insurance company that gives them. For detailed information on an annuity that guarantees a set income for life, click here.
  7. Variable Annuities within IRAs: Since IRAs are already tax-advantaged, a variable annuity will provide no additional tax savings. It will, however, increase the expense of the IRA, while often times generating fees and commissions for the salesperson.

How to Protect Yourself

Before purchasing a variable annuity, be sure to ask the person recommending the product the following questions:
  • How long will my money be tied up? Are there surrender charges or other penalties if I withdraw funds earlier than I anticipated?
  • Will you be paid a commission or receive any type of compensation for selling the annuity? How much?
  • What are the risks that my investment could decrease in value? (If you are told there are no risks, head for the door as the advisor is clearly not disclosing all facets of the product.)
  • What are all the fees and expenses?

If you’re considering the purchase of an annuity and would like a second opinion, seek the advice of a fee-only financial planner. These financial planning professionals are never paid commissions so you’re more likely to get an honest, objective opinion.

To read the entire investor alert published by FINRA, click here.

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