On the Annuities Alert

The Securities and Exchange Commission and NASD have three words for investors purchasing variable annuities: Watch your back.

Okay, they didn't exactly say this, but that's essentially what a new report by the two organizations recommends.

Variable annuity products combine features of insurance and securities investments. While variable annuities are appropriate for some, be careful if you're considering investing in these products. They are complex, with language and fee structures nearly impossible for the average consumer to understand. And, by average, I mean people who don't have Einstein-level IQs -- and even then there's no guarantee.

The report by the SEC and NASD (formerly the National Association of Securities Dealers) was released earlier this month and results from an examination of the way variable annuities are sold. The study itself was triggered by the growth in annuity sales and the large number of complaints from individual investors.

"The report outlines a number of weak practices identified during the examinations, and provides a road map to investors of sales practices to watch out for," said Susan Wyderko, the SEC's director of the Office of Investor Education and Assistance.

NASD said that among the more disturbing weaknesses identified were instances in which brokers made unsuitable recommendations to senior citizens and to individuals who could not afford the products without mortgaging their homes. Brokers also failed to fully disclose various fees or risks, and overstated the tax benefits associated with annuities.

In one complaint to the SEC that I was allowed to review (minus any identifying information), an elderly couple produced an e-mail in which a salesperson told them that having an annuity as part of their tax-deferred investment account (an individual retirement account, or IRA) was the same as a "double tax-deferred investment."

That's utter nonsense. It's true that one key benefit to purchasing variable products is that earnings on the invested money accumulate tax-deferred. "But purchasing a variable annuity within a tax-advantaged account will provide no additional tax savings," Wyderko said. "It will, however, generate fees and commissions for the securities salesperson."

The report also found that firms repeatedly went back to the same customers and switched them to a new variable annuity product every few years.

Here's the problem with that, according to Wyderko. A new annuity may impose higher fees and may reduce your death benefit, and you may have to pay a surrender charge on the old product.