SEC Warns Investors to Be Cautious of Variable Annuities
Federal regulators are warning investors to be wary about variable annuities, an increasingly popular way to save for retirement that combines features of mutual funds and insurance.
While they offer certain attractions--such as lifelong payments and death benefits--variable annuities also have some pitfalls that salespeople often don’t reveal to investors, the Securities and Exchange Commission said Monday.
The agency issued an “investor alert” and a brochure on its Web site (https://www.sec.gov/consumer/varannty.htm) to help investors understand the benefits, costs and risks of variable annuities.
The warning came as Paul Roye, director of the SEC’s investment management division, told an industry group that SEC inspectors have been gathering information on sales of variable annuities from brokerages and financial advisors around the country with an eye to possible sanctions.
The SEC is warning, for example, that bonuses offered by some financial companies selling variable annuities to lure investors may be outweighed by higher expenses. The bonuses, typically a small percentage of the value of the annuity, are in the form of credits applied to an annuity holder’s purchase payments.
The companies offering bonuses may, for example, charge higher penalties for withdrawals, the SEC said.
Mark Mackey, chief executive of the National Assn. for Variable Annuities, acknowledged that bonus credits “benefit some, but not all, investors.”
Variable annuities are sold by insurance companies, brokerages and other financial companies. Sales nationwide reached $120 billion last year, up from around $100 billion in 1998.
A variable annuity is a contract between an investor and the company selling it in which the company agrees to make periodic payments to the investor, beginning immediately or at some future date. The investor buys a variable annuity contract by making either a single purchase payment or a series of payments.
The returns to the annuity holder vary and are determined by the performance of the underlying investments.
Variable annuities generally offer several investment options, usually involving mutual funds that invest in stocks, bonds or money-market instruments, or some combination of the three.
With fixed annuities, by contrast, all payments to the annuity holder are equal.
Variable annuities differ from mutual funds in several important ways. They are tax-deferred, for example, which means annuity holders pay no taxes on the income and investment gains from their annuities until they withdraw their money.
In general, the SEC says, the benefits of tax deferral will outweigh the costs of a variable annuity only if it is held as a long-term investment to meet retirement and other long-range goals.
Individual retirement accounts and 401(k) retirement plans, which offer tax deferral at no cost, are often more advantageous than variable annuities, the SEC notes.
The agency issued the following advice:
* IRAs: If an investor buys a variable annuity for a tax-advantaged retirement plan such as an IRA or 401(k), he or she will get no additional tax benefit from the variable annuity. Investors should consider buying a variable annuity in that situation only if it makes sense because of the annuity’s other features, such as lifelong payments and a guaranteed death benefit.
* Charges: Before investing in a variable annuity, consumers should make sure they understand the charges that come with it, including sales charges, mortality charges, administrative fees and expenses of the mutual fund investment options.
* Exchanges: Investors who own a variable annuity and are considering exchanging it for another one should weigh the decision carefully. An investor who makes the exchange often loses the ability to withdraw money without paying substantial charges.
