Annuities Aren’t Right For Many Nest Eggs

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December 2008

RETIREMENT; Pg. 22 Vol. 6 No. 12

770 words

Annuities aren't right for many nest eggs

Jane White

Employers and advisers need to be wary of allowing employees who are near retirement

age with inadequate 401(k) balances to be misled by the annuity industry. Unfortunately, the annuity industry has been able to convince some members of Congress to make it easier to mislead people to think that the product can fill empty nest eggs.

The Retirement Security for Life Act of 2007 would amend the Internal Revenue Code to give favorable tax treatment to annuity income. For the average retiree, the tax break could approximate $5,000. As of press time, the bill has not been passed in the House or the Senate.

Under this bill, the tax savings would be offset by the money some annuity salespeople can generate from fees and questionable sales practices. Annuity sales misdoings are quickly becoming legend. Frisco, Texas-based financial planner John Gay, for example, says annuities are a "sucker's game dressed up to look like a free lunch."

In the past, annuity sellers concentrated on the retired market. Now their sights are set on baby boomers reaching retirement age that can't afford to retire. Here are just a few examples of how unscrupulous annuity sales have harmed plan participants and raised the ire of regulators.

In 2006, the Financial Industry Regulatory Authority issued an investor alert regarding annuity salespeople conducting workplace seminars in which they convinced employees to retire early, cash out of their 401(k)s and open an IRA that consists of a variable annuity. In one disciplinary case that FINRA prosecuted, the broker told the employees, "You can make as much in retirement as you can at work," promising that he could generate annual returns of 18%.

A similar pitch was made to Exxon Mobil workers in 1997. At least 32 of them fell for the broker's line and lost most of their money. In 2006, a FINRA arbitration panel awarded these workers $22 million. That same year, former New York Attorney General Eliot Spitzer announced an agreement in which one insurance company paid $30 million in restitution to the New York State Teachers Union and agreed to improved disclosures.

More recently Florida has passed a law increasing penalties on salespeople who generate commissions by selling customers new annuities. Meanwhile New Jersey has limited the time period in which sellers can impose surrender charges. California has increased jail time on bait-and-switch sellers.

The annuitization option puts a spotlight on one of the more unfortunate features of 401(k) plans, which is that retirees can and often do take their payments as a lump sum, even before they've reached age 59 1/2, when they incur taxes and penalties. Without good advice, they might spend it foolishly, rather than banking it and taking payments that will last a lifetime.

On the other hand, for the tiny percentage of 401(k) participants who have saved enough, there are other options besides annuities for providing income streams. For example, the mutual fund industry offers "managed payout" or "target distribution" funds.

At least in the case of payout funds offered by Vanguard Group, shareholders can make additional contributions or withdrawals without penalty. Since these are commission-free products, churning isn't an issue.

I suspect the real reason why such questionable bills are not only proposed, but also enacted is because campaign finance reform hasn't gone far enough. The 21 members of the Senate Finance Committee who think up laws that would affect the sales of insurance products received $26.5 million from the finance, insurance and real estate (FIRE) sector in the 2007-2008 election cycle. Nearly $5 million came from the insurance industry.

Wonder why we haven't had real mortgage reform that would have abolished the adjustable rate mortgage, which is the driver of the current mortgage mess? The 69 members of the House Committee on Financial Services responsible for the House version of one of the mortgage bailout bills received $21.4 million from FIRE in the 2007-2008 election cycle, according to data published by the Center for Responsive Politics.

It will take a while before we can replace members of Congress with lawmakers who vow to better represent their citizens, rather than campaign contributors. Until that time, let's hope America's human resource leaders will look out for the best interests of their employees by denying annuity sellers access to their savings.

Jane White is president of Retirement Solutions, an advocacy and educational organization dedicated to the retirement adequacy of 401(k) participants. She's also working on a book to be published early next year.

http://www.eba.benefitnews.com/

December 1, 2008