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Unethical sales practices in the annuity marketplace have increased over the last few years, according to the National Association of Securities Dealers, causing the organization to issue an “investor alert” on May 27, warning consumers about the product.

The alert, titled “Variable Annuities: Beyond the Hard Sell,” targets consumers who recently purchased or are considering purchasing deferred variable annuities.

“Marketing efforts used by some variable annuity sellers deserve scrutiny–especially when seniors are the targeted investors,” says Mary L. Schapiro, vice chairman and president of regulatory policy and oversight for the NASD, Washington, in a release announcing the alert.

Some sales pitches used by annuity marketers involve scare tactics, which can confuse investors and pressure them into buying the annuity, according to the alert.

“Sales pitches that confuse or frighten investors violate NASD rules and will be the subject of enforcement action,” says Schapiro, in the release.

The alert notes that while deferred VAs may be an appropriate investment given the right situation, investors need to be aware of the restrictive features, tax issues and fees associated with these products.

“We wanted to make sure that investors were alerted of some issues they should be aware of if theyre considering purchasing a variable annuity,” says John Gannon, director of individual investor services at the NASD, who authored the investor alert.

In addition to recommending that investors read the prospectus, the alert outlines seven factors consumers need to keep in mind when considering an annuity. These factors are:

1. Liquidity and early withdrawals. Since annuities are long-term investments, early access to values is limited. Surrender charges may last six to eight years, and withdrawals prior to age 59 1/2 are usually subject to a 10% penalty in addition to ordinary income taxes on any gains.

2. Sales and surrender charges. The alert compares annuities to “class B shares of mutual funds,” as many annuities do not charge front-end sales fees but instead assess an asset-based fee and a surrender charge, both of which usually decline over a number of years.

3. Fees and expenses. Mortality and expense charges, administrative fees, underlying fund expense charges and charges for special features may add up to as much as a 2% charge against the annuitys value each year, according to the alert. It warns investors to be aware of the special features they are paying for and to determine whether they need them.

4. Taxes. The alert describes the tax-deferred growth of an annuity as similar to that found in a 401(k) plan but without the tax deductibility of contributions. The alert also makes the recommendation that “most investors should consider annuity products only after they make their maximum contributions to their 401(k) plan and other before-tax retirement plans.”

Furthermore, the alert notes that at time of distribution, annuity earnings are taxed at ordinary income tax rates, rather than the lower long-term capital gains tax rate. Also, annuities do not receive a “step-up” in basis at the annuity owners death as other investments such as mutual funds, stocks and bonds do.

5. Bonus credits. Many companies offer special bonus credits for purchasing their annuity. The alert explains that these bonuses, while attractive, are typically subsidized by higher mortality and expense fees or a longer surrender charge period.

6. Guarantees. Benefits such as death benefits or guaranteed lifetime income are available in annuity products but “are only as good as the insurance company that gives them,” the alert says.

“We just want to make sure that investors understood what the guarantee is,” explains Gannon. For example, the guarantee an insurance company issues is different than the guarantee found in a certificate of deposit, which is backed by the federal government through the FDIC, he says.

“Its important in understanding the guarantee that investors check the credit rating of the insurance company,” Gannon says. “Its part of their due diligence.”

The alert explains that investors should consider evaluating a companys financial strength rating before making a purchasing decision.

7. Variable annuities within IRAs. The alert explains that purchasing an annuity within an Individual Retirement Account may not be in an investors best interest. The annuity provides no tax advantage but increases the fees within the IRA. Additional fees and commissions are also paid to the salesperson, it says.

The investor alert suggests that investors ask questions of those who are recommending a VA product to them. Liquidity and early withdrawal penalties should be discussed, and also the market risks associated with the investment. Investors are encouraged to ask questions about fees and expenses in the contract, as well as compensation the advisor receives from the sale.

For a complete text of the alert, visit the NASDs Website: www.nasd.org.


Reproduced from National Underwriter Edition, June 9, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.