Elder, Senior and Retirement Financial Abuse and Exploitation Relating to Variable and Fixed Annuities

South Florida Elder, Senior and Retirement Financial Abuse and Exploitation Variable and Fixed Annuity Fraud, Misrepresentation, Breach of Fiduciary Duty and Twisting FINRA Arbitration, Litigation and Probate Estate Attorney:

Recently, we were presented with the following factual situation. A single 82 year old, long retired woman received a "cold call" from a mortgage broker, who, after repeated telephone calls and visits to the woman's home, convinced her to refinance her residence, She somehow got the woman to believe that it would be beneficial to pay off her $200,000 fixed rate, first mortgage, on her house that she had owned for many years, and to take out a new variable rate mortgage for almost $1,000,000 and put the difference in the bank for emergencies. If that was not enough, the 82 year old woman took the net proceeds to deposit into a bank account and the securities arm of the bank got a hold of her. Instead of telling the woman that it was a terrible idea to have taken out the new first mortgage, the securities arm of the bank sold the woman an annuity for $500,000, which started paying her monthly for 10 years. All of the payments that the woman got went to make the monthly mortgage payments. Obviously, the problem that this created for the woman was that after 10 years she would not be getting any more income from the annuity and the principal balance of the mortgage would be unchanged, thereby building into the transaction an automatic default in the mortgage. This is but one of many examples that could be given to show the extent to which some variable sellers will go to sell a product because of the large commission associate with the product.

While variable annuities can be appropriate as an investment under the right circumstances, as an investor, you should be aware of their restrictive features, understand that substantial taxes and charges may apply if you withdraw your money early, and guard against fear-inducing sales tactics.

Many regulatory agencies, including FINRA, have issued alerts and newsletters to help seniors and other prospective variable annuity buyers to make informed decisions about how to invest for their retirement. This blog focuses solely on deferred variable annuities and the unique issues they raise for investors.

What Are Variable Annuities?

Although variable annuities offer investment features similar in many respects to mutual funds, a typical variable annuity offers three basic features not commonly found in mutual funds:

1. Tax-deferred treatment of earnings.
2. A death benefit.
3. Annuity payout options that can provide guaranteed income for life.

Generally, variable annuities have two phases:

1. The "accumulation" phase when investor contributions-premiums-are allocated among investment portfolios-subaccounts-and earnings accumulate.
2. The "distribution" phase when you withdraw money, typically as a lump sum or through various annuity payment options.

If the payments are delayed to the future, you have a deferred annuity. If the payments start immediately, you have an immediate annuity.

As its name implies, a variable annuity's rate of return is not stable, but varies with the stock, bond and money market subaccounts that you choose as investment options. There is no guarantee that you will earn any return on your investment and there is a risk that you will lose money. Because of this risk, variable annuities are securities registered with the Securities and Exchange Commission (SEC). The SEC and FINRA also regulate sales of variable insurance products. For example, FINRA has a number of rules that have been adopted concerning many aspects of the sale of and record keeping requirements relating to variable annuities. Moreover, because variable annuities are considered a security, the suitability rules of FINRA apply.

Evaluating Variable Annuities

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 all of its terms. Carefully read the prospectus. Here are seven factors you should bear in mind before investing:

1. Liquidity and Early Withdrawals

Deferred variable annuities are long-term investments. Getting out early can mean taking a loss. Many variable annuities assess surrender charges for withdrawals within a specified period, which can be as long as six to eight years.

Also, any withdrawals before an investor reaches the age of 59 ½ are generally subject to a 10 percent tax penalty in addition to any gain being taxed as ordinary income.

2. Sales and Surrender Charges

Most variable annuities have a sales charge. Like class B shares of mutual funds, many variable annuity shares typically do not charge a front-end sales charge, but they do impose asset-based sales charges or surrender charges. These charges normally decline and eventually are eliminated the longer you hold your shares. For example, a surrender charge could start at 7 percent in the first year and decline by 1 percent per year until it reaches zero.

3. Fees and Expenses

In addition to sales and surrender charges, variable annuities may impose a variety of fees and expenses when you invest in them, such as:

Mortality and expense risk charges, which the insurance company charges for the insurance to cover:

  • guaranteed death benefits;
  • annuity payout options that can provide guaranteed income for life; or
  • guaranteed caps on administrative charges.
  • Administrative fees, for record-keeping and other administrative expenses.
  • Underlying fund expenses, relating to the investment subaccounts.
  • Charges for special features, such as: (1) stepped-up death benefits; (2) guaranteed minimum income benefits; (3) long-term health insurance; or (4) principal protection.

These annual fees on variable annuities can reach 2 percent or more of the annuity's value. Remember, you will pay for each variable annuity benefit. If you don't need or want these features, you should consider whether this is an appropriate investment for you. In order that there is no misunderstanding on these additional charges, it is a very good idea to get the information in writing from the sales person. Sometimes relying of the prospectus or the terms of the policy is are difficult because they are not easily understood.

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 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. That's why most investors should consider annuity products only after they make their maximum contributions to their 401(k)s and other before-tax retirement plans. To learn more about 401(k)s, please read Smart 401(k) Investing.

Once you start withdrawing money from your variable annuity, earnings (but not principal) will be taxed at the ordinary income rate, rather than at the lower capital gains rates applied to investments in stocks, bonds, mutual funds or other non-tax-deferred vehicles in which funds are held for more than one year.

Furthermore, proceeds of most variable annuities do not receive a "step-up" in cost basis when the owner dies. Other types of investments, such as stocks, bonds, and mutual funds, do provide a step up in tax basis upon the owner's death.

5. Bonus Credits

In an attempt to attract investors, many variable annuities now offer bonus credits that can add a specified percentage to the amount invested in the variable annuity, generally ranging from 1 percent to 5 percent for each premium payment you make. Bonus credits, however, are usually not free. In order to fund them, insurance companies typically impose high mortality and expense charges and lengthy surrender charge periods.

Exchanging or Replacing Your Current Annuity

An exchange of an existing annuity for a new annuity may be the only way a salesperson can generate additional business. However, the new variable annuity may have a lower contract value and a smaller death benefit. You should exchange your annuity only when it is better for you and not just better for the person trying to sell you a new annuity.

6. Guarantees

Insurance companies issuing variable annuities provide a number of specific guarantees. For example, they may guarantee a death benefit or an annuity payout option that can provide income for life. These guarantees are only as good as the insurance company that gives them. While it is an uncommon occurrence that the insurance companies that back these guarantees are unable to meet their obligations, it happens. There are several credit rating agencies that rate a company's financial strength.

7. Variable Annuities within IRAs

Investing in a variable annuity within a tax-deferred account, such as an individual retirement account (IRA) may not be a good idea. 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 generating fees and commissions for the broker or salesperson.

Also, if the annuity is within a traditional (rather than a Roth) IRA, the government requires that you start withdrawing income no later than the April 1 that follows your 70½ birthday, regardless of any surrender charges the annuity might impose.

Contact Us:

With extensive courtroom, arbitration and mediation experience and an in-depth understanding of elder abuse, exploitation and securities law, our firm provides all of our clients with the personal service they deserve. Handling cases worth $25,000 or more, we represent clients throughout Florida and across the United States, as well as for foreign individuals that invested in U.S. banks or brokerage firms. Contact us to arrange your free initial consultation.

At the Boca Raton Law Office of Russell L. Forkey, we represent clients throughout South and Central Florida, including Boca Raton, West Palm Beach, Boca Raton, Sunrise, Plantation, Coral Springs, Deerfield Beach, Pompano Beach, Delray, Boynton Beach, Hollywood, Lake Worth, Royal Palm Beach, Manalapan, Jupiter, Gulf Stream, Wellington, Fort Pierce, Stuart, Palm City, Jupiter, Miami, Orlando, Maitland, Winter Park, Altamonte Springs, Lake Mary, Heathrow, Melbourne, Palm Bay, Cocoa Beach, Vero Beach, Daytona Beach, Deland, New Smyrna Beach, Ormand Beach, Broward County, Palm Beach County, Dade County, Orange County, Seminole County, Martin County, Brevard County, Indian River County, Volusia County and Monroe County, Florida. The law office of Russell L. Forkey also represents South American, Canadian and other foreign residents that do business with U.S. financial institutions, investment advisors, brokerage and precious metal firms.