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Many investors have gotten into trouble by investing in annuities in recent years. The right annuities can make appropriate investments for some people. The state of the financial markets in the early 2000s, however, caused many brokers to push annuities onto investors for whom they were less suitable.
Many investors fail to understand or take into consideration that brokers are paid for selling investments.
Brokers usually receive a 2-3% commission when they sell a mutual fund. With annuities, the commission can be as high as 7-10%. The broker also gets a trailer fee over time without doing anything (they do not manage the money). With these kinds of incentives, it is clear why brokers are tempted to push annuities even when they are not suitable investments.
During the 1980s and 1990s several brokers got used to a high-end lifestyle from all their stock commissions. When the market declined and clients were no longer interested in buying and selling as they once did, brokers had to change the way they did business in order to maintain their high incomes. Selling annuities offered them a way to maintain that income level. Some even moved client moneys into these annuities, took the huge commissions and left the industry, effectively taking a golden parachute for themselves, leaving others to clean up the mess.
Many investors were shaken by the slump in tech stocks that happened in 1999 through 2002. They looked for a safer investment. These investors were prime targets for brokers selling variable annunities.
Annuities were particularly attractive to people looking for a fixed income and early retirement. They thought they were getting a certain amount per year for life. Many of these investors were in for a shock when the market dropped. They ended up with a penalty interest problem and with less than half their original investment, unemployment, and an expensive lifestyle.
In contrast to what many investors believed, these annuities are still risky investments like stocks, but even worse, because the investors are locked into the investments due to the fees, structures and tax consequences. Owners have to pay a surrender fee to get their money out, usually the amount of the sales commission. Owners are also locked in because a sale will result in major tax implications.
Investors were also led to believe that their principal was protected. This wasn't completely true. People were also led to believe they are analogous to life insurance policies. This isn't entirely true either.
Annuities are like mutual funds wrapped up in an insurance policy. There is normally a death benefit related to the amount of money paid in. They were often sold as a guaranteed or insured "can’t lose" policies. Annuity managers typically put the money in subaccounts of mutual funds which can be very aggressive; if they go down in value, the surrender value of the annuity decreases. If you invest $500K in one and the market goes down your investment could have a value of $250K.
Read about SEC recommendations to prevent becoming a victim of variable annuities fraud.
You may also be interested in reading a case study involving the sale of unsuitable annuities.
You can learn more about index annuities here.News Stories on Annuities
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