Zeke Faux’s Bloomberg article, “Indexed Annuities Can Yield Surprises,” focuses on complexity of the contracts that obscure high fees and long lock-up periods, and the fact that investors do not understand these products.
$32.1 billion if indexed annuities were sold in 2010, a record, according to the article. But Barbara Roper, director of investor protection for the Consumer Federation of America, calls indexed annuities “one of the most abusively sold products on the market today,” according to the article. And Dan Keady, TIAA-CREF’s director of financial planning, says, “Very few people understand what the product is.”
Indexed annuities come with fees and expenses that are generally much higher than mutual funds.
The long lock-up period is enforced by the surrender charge. Indexed annuity contracts provide for surrender charges if a policy is canceled or money in excess of a certain amount is withdrawn during a set period that can range from 3 years to 16 years. Indexed annuity sellers say that many contracts permit a 10 percent penalty-free withdrawals annually. The Internal Revenue Service, however, imposes a 10% penalty on any distributions made before age 59 1/2.
While indexed annuities are touted for their combination of downside protection and upside potential, experts say that certificates of deposit provide better returns and better safety. Unlike CDs, indexed annuities give investors “haircuts” while they are asleep in the chair, so to speak. For example, the upside is typically limited by a “performance cap” and is often further reduced by a “participation rate.” On top of that, the issuer makes a “market value adjustment,” a complex calculation that usually reduces the cash value of the account. Haircuts are almost always not explained to investors.
Salespeople downplay the complexity of indexed annuities and their long lock-up periods, according to Ms. Roper. Why? Insurance companies pay sales commissions as high as 12 percent. Firms have also been known to have sales contests with winners receiving valuable prizes and benefits, such as free trips to Disney World.
Those considering purchasing an indexed annuity should note that state regulators have sued or issued warnings about deceptive sales of indexed annuities. ??Last year, a federal jury found that Allianz Life Insurance Co. of North America, the nation’s top indexed annuity seller and a unit of Allianz Se, misrepresented one product by promising a 10% “bonus” to hundreds of thousands of buyers. The bonus was illusory and could not be cashed.
Some insurance companies have made a decision not to offer index annuities. Those companies include Met Life, Prudential, New York Life, and TIAA-CREF.
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