Annuities tied to indexes are drawing fire for their hype

PERSONAL FINANCE

August 21, 2005|By Eileen Ambrose

ONE OF THE BASICS of investing is to never put money in anything you don't understand.

That's important to remember when it comes to equity-indexed annuities, which are touted as a way to participate in the stock market's growth without any downside risk.

But anytime you invest there's risk. And there's mounting concern among regulators and others that these complex annuities are being hyped to investors without fully pointing out the risks, including the possibility of losing money.

Sales have surged in recent years, from $14.4 billion in 2003 to $23.1 billion last year, according to the National Association for Variable Annuities.

"Whenever I see a product so overly sold, my antenna goes up and says, `Buyer beware,' " said J.J. Burns, a financial planner in Melville, N.Y.

An annuity is a contract with an insurance company. Money grows tax-deferred, and investors often choose to receive a payout in retirement over a certain number of years or over the rest of their lives.

Basically, an equity-indexed annuity promises a minimum return, often 3 percent a year on 90 percent of premiums paid, experts said. But it also offers investors the chance to earn a higher rate - within limits - by linking their return to an index, frequently the S&P 500. So, if stocks soar, investors can see a bump up in interest earned, but not as high as the index gain.

Sounds simple, but indexed annuities are anything but that. There are so many in the marketplace and each has its own twists that even the most vigilant of investors will have difficulty comparing one with another.

Burns said the annuities have been aptly described as, "If you've seen one equity-indexed annuity, you've seen one."

The methods for calculating indexed interest are particularly complex.

Investors often receive interest on a portion of the index gain, and there can be an additional cap as to how much they can earn. There are multiple formulas for measuring changes in the index. And when that interest is credited, the annuity varies, too.

Contracts can last five or 10 years, or longer. The annuities typically carry steep surrender charges if investors bail out early, causing them to lose money. For instance, an investor may forfeit 10 percent by cashing out the first year, with the charge gradually dropping over time.

"It could take five or six years before it starts going down," said James F. Ludwick, a financial planner in Odenton.

(Investors typically can withdraw up to 10 percent a year without penalty, although they might forfeit indexed interest on that amount.)

On top of this, those who sell these annuities earn big commissions, sometimes 10 percent or more, Ludwick said.

Most equity-indexed annuities are not registered as a security, so they come under regulation of state insurance regulators. That means 50 variations of regulations, and some states are tougher than others, Ludwick said.

There's speculation that the Securities and Exchange Commission is looking into the regulation of these annuities because they are marketed for their stock index feature. The SEC won't comment.

The NASD, an industry group that regulates its brokerage members, is concerned about the marketing of these annuities and offered guidance this month to brokers who might sell them.

"There is a place for these, but there is a limited place," said Burns, adding that investors should never put their entire nest egg in these annuities.

Ken Little, author of The Pocket Idiot's Guide to Annuities, said indexed annuities could be suited for those in their 40s and 50s who already maxed out on contributions to retirement plans.

But they are not for anyone who needs immediate income. "Like any product tied to the stock market, it is a long-term investment," Little said. "I would be suspicious or concerned if I'm already retired and somebody tried to sell me these."

Michael Bischoff, a financial planner in Bloomington, Minn., said he's recommended five- to seven-year annuities for clients approaching retirement who want to be more conservative, yet have some upside possibilities.

He also recommended it a few years ago to an investor who couldn't sleep at night during the bear market. This way, when the market rebounded, the client could earn more than if his cash sat in a money market account, Bischoff said.

And Ludwick, admittedly no fan of these annuities, recommended one for a client in his late 40s who had trouble sticking with investments for his retirement. The client sold as soon as the market fell, even when he had money in individual retirement accounts that carry a penalty for early withdrawals.

Ludwick recommended the annuity, figuring the onerous surrender charges would keep the client invested. So far, it's worked, Ludwick said.

It is best to never buy an indexed annuity without asking lots of questions.

What index is being used? "Some are more volatile than others," Little said.

What are the surrender charges? How is the indexed interest calculated and when is it credited to the annuity?

Ask what commission the salesperson will receive, and how does compares with those on other products, said Thomas M. Selman, senior vice president of the NASD.

"Under what scenarios can they lose money? Is it 90 percent guaranteed principal or 100 percent guaranteed?" Selman added. "If the [agent] says, `No way you can lose money in this,' ... the consumer should be very skeptical."

"Make sure the company backing the annuity is a reputable company," Little advised. If it's not, the insurer may not be in business when it's time to get your money, he said.

And if you experience immediate buyer's remorse, the situation isn't hopeless. Annuities offer a "free look," which gives investors 10 to 30 days to back out of a contract without penalty, Little said.

To suggest a topic, contact Eileen Ambrose at 410-332-6984 or by e-mail at eileen.ambrose@baltsun.com.

Baltimore Sun Articles
|
|
|
Please note the green-lined linked article text has been applied commercially without any involvement from our newsroom editors, reporters or any other editorial staff.