Use caution with annuities

Your Money

August 28, 2005|By Humberto Cruz

Q: My husband purchased an annuity through a dishonest agent. It is a fixed account that will pay just 2.25 percent for the next 11 years. It has been almost a year since he bought it, and they will charge a surrender charge of 14 percent if he wants to take the money out. Still, we want to transfer the money and open an IRA with a no-load mutual fund or discount broker. Would this be a wise decision?

A: It would be an impossible decision as far as the money in this annuity is concerned. Legally, you cannot take money from an annuity that is not part of an individual retirement account or a qualified retirement plan and turn it into an IRA. From the information you gave me, your husband made a lump-sum payment of $11,000 to buy what is known as a nonqualified annuity, one bought with after-tax dollars and not part of a tax-qualified retirement plan.

I do not know whether the agent who sold your husband the policy is dishonest, since I wasn't there to witness the transaction, but I will bet anything that the contract your husband has had for almost a year spells out the surrender charges and interest rate guarantees.

Also by law, annuities must include a "free-look" provision, giving you enough time - typically a minimum of 10 to 30 days - to look over the contract and cancel it if you don't like the terms.

What I'm saying is, your husband must take some of the responsibility for having bought this annuity contract. Still, if he feels the agent was less than honest and failed to disclose important information, he should contact his state insurance department and file a complaint. In some recent cases involving the questionable sale of annuities, particularly to seniors, insurance companies have agreed to drop surrender charges in the face of customer complaints and pressure from regulators.

If your husband's insurance company won't drop the surrender charges, then you need to decide whether he is better off sticking it out with this annuity and earning the 2.25 percent a year tax deferred, or paying the piper and putting the money somewhere else. In the latter case, if the policy is not quite a year old yet, he might want to wait until the first policy anniversary, when surrender charges often go down by a percentage point.

I can't make that decision for you, but I will suggest your husband can learn a valuable lesson from this experience.

Based on what you told me, I am almost certain he bought a teaser-rate annuity that paid a bonus rate the first year but then guaranteed no more than 2.25 percent in years two through 12. His mistake was buying an annuity with a surrender-charge period that extended way beyond the time an attractive interest rate was guaranteed.

And I suspect he failed to ask for a critical bit of information: the guaranteed "yield to surrender," based on the lowest interest rate allowed under the contract, in this case 2.25 percent.

The guaranteed yield to surrender is the minimum you would earn if you hold the annuity until the end of the surrender period. For investors, that is the rate that really matters, not the one-year bonus rate that many insurance companies like to hype. For example, a fixed annuity I saw advertised recently paid a juicy 7 percent the first year, but the guaranteed yield to surrender, after 12 years, was a mere 1.5 percent a year.

Q: I've seen some ads from banks that offer certificates of deposit with good rates. The ads state that the banks are federally insured. How can I find out if the account is really insured, as the ads claim?

A: You can call the Federal Deposit Insurance Corp.'s toll-free consumer assistance line at 877-275-3342 or go to the Web site www.fdic.gov. While you are there, you might want to take a look at a wealth of high-quality consumer information the agency provides at no cost.

In particular, I am a big fan of the FDIC Consumer News, a quarterly newsletter filled with plain-English tips to help people protect and stretch their money. You can check current and past issues at the Web site www.fdic. gov/consumers/consumer/news, or ask to be sent a print version by calling the FDIC number above.

Humberto Cruz is a columnist for Tribune Media Services. E-mail him at yourmoney tribune.com.

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