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VOICES FROM THE INDUSTRY: How variable annuities can ruin a good vacation

May 28, 2007

As I'm sitting on a sunny Mexican beach during vacation enjoying yet another all-inclusive beverage, all I can think about is how much I hate variable annuities.

I despise them. Whether you are north or south of the Rio Grande, you should understand that variable annu ities, or VAs as they're called in the industry, are typically lousy investments for just about everyone.

This vacation was almost ruined by my associate, who put in my stack of reading materials an article reminding me that over $3 billion of VAs were sold to Hoosier investors in 2006. What a nightmare! It's like your wife getting Montezuma's revenge on the third day of vacation. It's pretty ugly.

There are so many reasons to detest VAs, it's difficult to pick the major ones due to the limitations of column space. So, here goes.

Investments for sale

VAs are sold to investors, not bought by them. In the history of investing, the following words have only been spoken by a few investors, "Do you have any good variable annuities today?"

It virtually never happens that an investor asks about this product. It is simply recommended to him by an advisor. Anyone who gave an honest answer to this question would have to admit that a "good" VA is like "clean" Mexican water. You drink at considerable risk.

So why do billions of lousy VAs get sold to so many unsuspecting investors? Because the brokers make mucho, mucho pesos on these sales.

VAs are usually one of, if not the top, commission-making products in the marketplace today. A broker and his firm usually make a 6 percent to 8 percent total commission on the principal invested in a VA. Ay caramba! This huge commission is almost never disclosed by the broker to the investor, because it would kill the sale on the spot.

Just like I speak almost no Spanish, most investors don't speak or understand "prospectus-ish." You have to be a securi ties lawyer to dig into a VA prospectus to discover the total commission paid to an advisor. Most investors don't know their advisor's financial incentive to recommend the VA.

Elusive benefits

There are 2 main benefits advisors tout for investing in VAs: One, the principal invested is guaranteed and, two, there are significant tax benefits.

Although both are true, they are also illusory. For most VAs, if your principal declines due to poorly performing subaccount investments, your principal is guaranteed so long as you do one thing-die! That's right, take the never-ending dirt nap. The burial of senor investor will trigger the guarantee. Not such a good deal for most investors.

The other purported advantage is tax benefits. While VAs are tax-deferred on their annual growth, when you do pay taxes it's at the ordinary income tax rate, not the capital-gains rate like most other long-term investments.

And the biggest abuse of all is selling VAs into retirement and individual retirement accounts. You should fire your advisor on the spot if he suggests this.

Don't just take my word for it, as both the National Association of Securities Dealers and the Securities and Exchange Commission have issued investor alerts warning about the practice of selling VAs into retirement accounts.

The annual costs of administering VAs are ridiculously high and can run 2-percent to 4-percent higher than other accounts. This is why the insurance companies that sell them love VAs, and the investor should avoid them like a bad enchilada.

This annual cost is much higher than comparable investments available to investors and is an unreasonably high cost that comes out first, before the VA is profitable for the year. Almost any other investment product carries annual costs lower than VAs.

I need to stop getting so worked up over VAs and enjoy what's left of my vacation. Maybe I can order another beverage in memory of all those investors burned by VAs.

Waiter, I'll have a Mayan Sacrifice, por favor.



Maddox is a former Indiana Securities Commissioner and an investor attorney with the Fishers firm of Maddox Hargett & Caruso P.C. Views expressed here are the writer's.
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