Annuities may be a good investment if you're a long-term investor and can use the tax benefits. But state insurance regulators say some agents eager for commissions are pushing annuities on older investors who would be better off putting their money elsewhere.
"We're seeing complaints where senior citizens are being coaxed to liquidate CDs, stock accounts and savings accounts and roll them into an annuity," said Barry Lanier, assistant bureau chief for the Department of Financial Services' Bureau of Investigations.
An annuity is an investment inside an insurance wrapper. Some annuities pay a fixed return for a set number of years or for the investor's life. Others have a variable return, fluctuating in value with the stock and bond markets.
For older investors, one of the biggest drawbacks is that many annuities levy steep surrender penalties if you want your money back before the term of the contract is up. Lanier said Florida investors in their 70s and 80s are being sold annuities with surrender charges that start out as high as 25 percent of the amount invested and may last as long as 15 years.
Many long-term annuities are sold with enticing "bonus" rates that are only good for the first year. After that, the rate drops sharply. Investors who don't comply with all the terms, including leaving the money in the annuity for the specified period, lose the bonus.
"People need to understand that if they (insurance companies) are offering something that sounds like a fantastic deal, they're going to get their money back somehow on the back end," Lanier said.
Tom Gallagher, the state's chief financial officer, is proposing legislation that would require agents who sell annuities to collect information about a customer's finances, tax status and investment objectives to document that the annuity is a suitable investment.
Investors also should ask themselves that question.
Income taxes on annuities are deferred until the money is withdrawn, when payments are classified partly as taxable interest and partly as tax-free return of principal. The tax benefits are good for workers saving for a retirement many years away, but little help to short-term investors or those who pay little or no taxes.
Variable annuities come with investment risks that make them inappropriate for conservative investors who don't want exposure to stocks and bonds. For investors who do want that exposure, mutual funds offer a lower-cost alternative.
Lanier said investors should be very skeptical if an agent tries to get them to switch from one annuity to another, especially if the switch would trigger a surrender penalty. The motive may be to generate a new commission for the agent, he said.
"Sometimes the agent will say that the bonus interest rate on the new annuity will more than make up for the surrender charge, but that's rarely the case," he said.
Lanier also said investors need to pay close attention to the terms of an annuity to be sure they understand how it works. He said that is particularly true of newer equity index annuities that pay a rate of return that is tied to the stock market but never produces a loss.
"It sounds like you can't lose, but they are very complicated," he said. "A lot of times the consumer truly does not know how much of the rise in the stock market they're going to participate in. When the numbers get crunched, it's a very small amount."