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A variable annuity combines mutual funds that offer tax-deferred compounding with insurance features. Rates of return on variable annuities vary, and regulators have recently stepped up scrutiny of variable annuity sales practices in response to numerous investigations turning up violation in how they are marketed and the risks disclosed.
The SEC is considering a new rule on annuities sales, and the NASD, or the National Association of Securities Dealers, is considering tighter regulation of annuities indexed to the stock market. In part because of the high commissions annuity salespeople can benefit from, the industry has become about a $1.1 trillion in annual sales business. With tighter federal regulation of annuities, regulators hope investors are able to get more information about the variable annuities to better determine if it fits their specific goals.
While fixed or immediate annuities guarantee an income stream for life, variable annuities are undesirable for certain populations from a retirement tax planning perspective because contributions and withdrawals from annuities are fully taxable at marginal personal rates up to 35 percent. Unlike a typical mutual fund investment, variable annuities allow investors to receive periodic payments for the rest of their life, has a death benefit and are tax deferred. However, variable annuities are designed to be long-term investments, to meet retirement and other long-range goals, so significant taxes are other charges can apply should the investor withdraw the money early. The majority of people who buy variable annuities either withdraw the funds or die before annuitizing.
For most investors, making the maximum allowable contributions to IRAs and other 401(k) plans will make more sense because of the tax-deferred growth and other tax advantages, and investing in a variable annuity may not be as advantageous. In addition, investing in a variable annuity through a tax-advantaged retirement plan will have no additional tax advantage from the variable annuity. For these reasons, investors should consider variable annuities only if it makes sense because of other features the annuity could offer that individual.
Tax rules applying to variable annuities can be complicated, but the annuity business has long been criticized by regulators and consumer advocates for misrepresenting its products and preying on senior citizens. As a result, a number of states have been implementing laws that would increase the oversight and scrutiny of some annuity sales, with special emphasis on provisions limiting the amount of time annuity sellers can impose penalties. After the Securities and Exchange Commission and the National Association of Securities Dealers fond widespread “weak” practices regarding sales suitability, disclosure, supervision and training in an examination of broker-dealers who sell variable annuities, the proposed NASD regulations were made to require plain English to explain annuities and require a supervisor to double check whether an annuity sale is even appropriate before a contract is issued.
Annual annuity sales have more than doubled in the past decade, hitting a record high in 2004, but the number of complaints is also mounting. In response, states are beginning to take action. Variable annuities can offer seniors an income they never can outlive, but only when properly used. Because so many investors do not understand the terms of the contract, seniors especially are sold annuities ill suited to their needs. NASD proposed regulations would address this problem by clearly outlining how annuities work.
Before considering purchasing a variable annuity an investor must learn as much as possible about what benefits it will specifically provide them, as well as the charges they involve. Financial professional selling variable annuities have a duty to advise potential investors whether it is fitting of their individual investment needs.
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