Variable annuities are a popular investment for providing income later in life, usually after the investor retires. But variable annuities are complex instruments, and aren’t suitable for many investors. Variable annuities are a common source of financial advisor and brokerage misconduct complaints.
What is a Variable Annuity?
A variable annuity is a contract between an investor and an insurance company. The investor makes either a lump sum payment at the outset, or a series of payments, that the insurance company invests into subaccounts. Usually, the subaccounts are mutual funds that invest in stocks, bonds, money market instruments, or some combination of the three.
Variable annuities have two phases: the “accumulation” phase, and the “distribution” phase.
- During the accumulation phase, the investor’s purchase payments are allocated into the subaccounts they have chosen.
- During the distribution phase, the investor begins to receive back their purchase payments (the principal), in addition to any income gains.
Features and Disadvantages of Variable Annuities
Investopedia calls variable annuities “mutual funds with an insurance wrapper.”
While variable annuities are typically invested in mutual funds, they differ from mutual funds in some important ways, including:
- Variable annuities offer tax-deferred growth. Investors pay no taxes on the annuity’s contributions and investment gains until funds are withdrawn.
- Variable annuities provide a death benefit. If the investor dies before payments begin, a named beneficiary receives a specified amount.
- Variable annuities allow periodic payment options. The option to receive periodic payments can provide income for the rest of the investor’s life, and protect against the investor outliving their assets.
These features can make variable annuities a good investment option for certain investors, but the following drawbacks should also be taken into consideration:
- Lack of liquidity. Once a payout option is chosen, the terms are frozen. The investor not only cannot touch the funds until age 59 ½ without incurring a tax penalty, but if the contract is annuitized, they may not live long enough to break even on it. And getting out early could mean taking a loss or paying a severe surrender penalty.
- Charges, fees, and expenses. Many variable annuities tack on costs such as surrender fees, sales charges, mortality and expense risk charges, administrative fees, fund expenses, and special feature charges. According to FINRA, these can reach 2 percent or more of the annuity’s value annually.
- Gains tied to performance. The money put into a variable annuity can actually decrease depending on how the chosen investment option performs.
Potential for Misconduct
The complex contract features and options of variable annuities make them unsuitable for many investors. But because annuity commissions are almost always greater than mutual fund commissions, stockbrokers may be incentivized to sell these products to investors even when they are not suitable.
Variable annuities are a leading cause of FINRA investor complaints. This has prompted FINRA to impose strict rules and responsibilities regarding variable annuities sales. For example, FINRA Rule 2330 requires brokers and firms to make efforts to ensure that customers understand the risks and features of a variable annuity, including charges, potential tax penalties, risks, and market costs.
Recovering Your Losses
When financial advisors don’t follow these guidelines — and an investor loses money as a result — the investor may be able to recoup their losses through FINRA arbitration or in the courts.
Whether in arbitration or court, the Morgan & Morgan Business Trial Group helps investors recover their financial losses on a contingency basis. This means we are only paid if we successfully recover money for you.
Backed by the size and skill of the largest contingency law firm in the nation – with more than 500 lawyers and 50 offices throughout the country – the Business Trial Group has helped investors recover tens of millions of dollars from the nation’s largest brokerage firms, investment advisory firms, and banks.