Variable Annuity Disputes

Our attorneys have extensive experience representing investors in disputes with life insurance companies or financial advisors concerning variable annuities.  Annuities are financial products that provide a stream of income for an investor. They come in many forms, but all share the same basic principle: they pay out money over time after retirement. Our attorneys often encounter the following fact patterns when analyzing an annuity case.  If you are someone you know would like to discuss an annuity case, please call us at 212-203-9300.

Overconcentration

Variable annuities are products that generally pay high commissions and fees.  Unfortunately, it is very common for financial advisors to concentrate their clients in other investments, like annuities, that pay high commissions.  A common fact pattern for us involves situations where a client’s account is heavily concentrated in high commission products, including non-traded REITs and business development corporations.

Misrepresentations or Fraud

We frequently handle cases where a financial advisor simply lies to a client about the features of an annuity. Often these misrepresentations are “innocent,” meaning they may be the result of the financial advisor simply not understanding the annuity.  Although the mistake may be innocent, a financial advisor in this situation would be liable to pay his or her client money damages of their negligence.  Although it is less frequent, we have also handled cases where a financial advisor knowingly misrepresents the features of an annuity.

Annuity Switching

Annuity switching, also called annuity churning, is a practice by which a financial advisor convinces a client to buy and sell annuities simply to generate commissions.  Often the salesperson will try to convince the client that new products have different or special features.  These types of cases most commonly arise when a financial advisor moves clients to a new firm and news to generate new sales.

What is an Annuity?

Annuities are often viewed as complicated financial instruments, and many people don’t know all the details before buying one. It’s essential to learn the basics of an annuity to understand how it might work for your retirement income.

Annuities are a type of life insurance policy that pays out money (usually monthly) to either the person who bought it or their beneficiaries until they die. This means if you buy an annuity today, you can guarantee yourself a set amount of income for the rest of your life.

The annuitant (the person who receives the payments) does not have ownership rights in the underlying investments. In other words, they rely on the judgment of an insurance company as to how much money will be available at any given time during retirement. In exchange for this relinquishment of control over their future finances, investors receive steady income over time with less risk associated with market fluctuations or changes in asset value.

Annuity Types

Annuities can be categorized into two types: deferred and immediate.

Deferred

Deferred annuities are pensions that come out of your paycheck and then go into an annuity. People usually apply for this type of annuity when they have time on their side, such as people who are 60 years old but still have a few more years before they retire.

Immediate

As the name suggests, an immediate annuity allows you to receive the annuity payout almost immediately after investing your money. You might want to apply for this type of annuity if you are about to retire and want to get monthly payments as quickly as possible.

Both types are also categorized into three subtypes: fixed, variable, and indexed annuities.

Fixed Annuity

Fixed or fixed-rated annuities are often the most common because they provide guaranteed returns. The downside is that these annuities do not earn much interest rates, and you have no control over how the account is invested. Fixed annuities might be a good option for people who work for organizations that don’t offer pensions or are self-employed.

Variable Annuity

Variable annuities, on the other hand, offer higher interest rates, but the downside is that there’s no guarantee of a minimum payout—even if you put your money in for just one year, it could be worth less than what you originally invested due to market volatility. Variable annuities might be better suited for people with a high-risk tolerance. There is also a greater possibility that the account will grow over time.

Equity-Indexed Annuity

Equity-indexed annuities are a type of annuity tied to the stock market, such as the S&P 500, offering potentially higher returns than a fixed annuity. Indexed annuities are for those with medium-risk tolerance and want to increase their chances of earning more in interest rates.

Regardless of which type you choose, it is imperative to know the possible fees associated with annuities. You must understand the contract you are being offered and the different kinds of annuities before investing. Ask, for instance, if there is a surrender charge, what are the fees associated with annuities, and how will they affect you?

The Basics of Annuities

To understand annuities, you must be familiar with the fundamental terminologies associated with them. Knowing the following terms will help you understand the contract and the different types of annuities. You must not buy an annuity without fully understanding the terms and the possible consequences.

INFLATION: The rising prices of goods over time that erode the value of a fixed-income investment, which is why retirees are advised to have alternative sources of retirement income besides just bonds or annuities.

ANNUITANT: The person who is being paid a lifetime income.

SURRENDER CHARGE: A penalty that annuity providers charge if the money in an annuity is withdrawn before a certain period of time passes, usually seven to ten or even fifteen years.

CAPS: The maximum limit to what an investment can earn in a year.

FLOORS: They are a guarantee that the investment will not drop below a certain level.

PARTICIPATION RATE: The amount of money an annuity provider pays when the markets are doing well. Cap and participation rate are not either/or; they’re both possible features of an annuity.

SPREAD MARGIN OR ASSET FEES: The fee annuity providers may charge on all the assets in your account.

DEATH BENEFIT: The money that goes to a beneficiary or heirs of an annuity holder who dies while receiving income from it, often after seven years have passed.

BONUS: A higher rate of return annuity providers offer for a limited period to encourage enrollment.

RIDERS: Additional features that are typically added to an annuity, such as a death benefit, for an extra cost.

Five Things to Look Out For :

Buying an annuity is a complicated decision, and there are many things to consider before purchasing. Consider these five points when deciding whether or not to buy an annuity:

Credit Worthiness of the Insurance Company

The issuer of the annuity is a critical factor in determining whether you should buy it. All insurance companies are not created equal, and some have better records than others for paying out money when they’re supposed to. To make sure that your future income stream will be secure, look into an insurer’s financial strength by checking its rating from agencies like A.M. Best or Standard and Poor’s, as well as its financial stability rating from agencies like Moody’s Investors Services or Weiss Research when possible. Triple-A ratings are the best, and CCC ratings are the worst. Ideally, you want the annuity issuer to have triple or double-A ratings. The reason for this is that a lower-rated insurer could eventually go bankrupt, leaving the annuity holder with no income or recourse to collect what they’re owed.

The Fees

You must also take into account the fees and expenses associated with an annuity. While some annuities don’t have any fees (they are built-in to the payout stream), others charge a variety of fees like sales charges, rider fees, and administrative expenses. These costs reduce your earnings over time, so it’s critical to consider them when choosing which annuity is best for you.

What Is the Minimum Guarantee?

You must understand the minimum guarantee for an annuity because this will affect how much money it can earn. Some annuities have a guaranteed rate of return and are sometimes referred to as fixed-rate or low-risk annuities. With these types of policies, your account balance won’t decrease in value even if the market falls. The only drawback is that with a fixed-rate annuity, you’ll never see your account balance increase either—you are guaranteed a certain minimum payout, but there’s no prospect of increasing principal value like with other types of annuities.

Can You Invest Your Annuity Money?

An annuity contract may not allow the annuitant to invest all or part of their funds—in which case, you’ll need to buy an annuity with a variable or adjustable interest rate. In this type of policy, there is no guarantee that your account balance will increase, and it might even decrease in value during periods of market volatility. This makes these types of annuities high-risk and high-return—which could be good or bad depending on the context.

The Surrender Charge

Surrender charges are a fee that is assessed if you withdraw from your annuity before the surrender period has expired. A surrender period is usually seven years. After the surrender period has expired, there is no penalty for withdrawing from the annuity. If you withdraw your money before that time period has elapsed and are assessed a surrender charge, this fee will reduce your account balance. Therefore, it’s essential to consider such terms when choosing an annuity.

Why Do People Buy an Annuity?

People buy annuities for a variety of reasons. Below are the most common ones:

To provide a guaranteed stream of income after retirement

The most common reason for buying an annuity is to provide a guaranteed stream of income until death. People are often worried about their ability to continue working into old age and want a steady income stream they can depend on. This is especially the case for people who believe their social security or pensions won’t provide enough income once they retire. They want more stability and peace of mind knowing their financial needs will be met even if they live a long time.

To Support Heirs

The second most popular reason for buying an annuity is to provide heirs with a steady income stream. This is often the case for people who have an estate they want to distribute and know it would not be enough in just a few years. They can use their annuity income as a way of guaranteeing their heirs will receive money from them regularly until death—even if that comes decades after the original purchase of the annuity.

To Protect Your Principle

The final most common reason for buying an annuity is to protect your money. This might be the case if you have a lot of savings or investments and want a way to ensure that they won’t decrease in value during periods of market volatility—you could use the income from your annuity as a sort of insurance against this possibility.

To Defer Taxes

An annuity is like an individual retirement account (IRA) for tax purposes. That means any money you invest is tax-deferred until withdrawal. But remember, just like an IRA, if you withdraw it early, you will be subjected to a 10% penalty. That is in addition to the fees that you might have to pay to your insurer. Don’t mistake tax deferral with tax-exempt. When you withdraw the income after retirement, your money will be subject to ordinary income taxes.

Reasons for NOT Buying an Annuity

There are many factors and considerations that come into play, like your age, the length of time until retirement, how much risk you’re willing to take on with your money. Annuities are often touted as a good retirement plan, but they’re not always the best option. Critics point out the following drawbacks of buying an annuity:

Inflation

Even though fixed annuities offer guaranteed income, their income can be eroded by inflation. If the annuitant lives a long time and inflation is higher than what they are earning in interest, then after taxes-inflation could wipe out much of the money that was initially invested. In other words, your money will not be worth as much in the future. For example, a gallon of milk used to cost $1.15 in 1970. It costs more than $3 today. Forty years ago, you could buy a house for $23,000. Today, you need ten times more—$200,000—to buy the same house.

Lack of Control

Some people also don’t like the idea they’re locking up their money for a period of time with an annuity. They might want to have access at any point in the future if something happens or they change their mind—which is possible, but it could cost them a hefty penalty. Furthermore, investors must be aware that in some instances, insurance companies can change the terms of the contract even after it’s sold.

Critics of annuities will often point out that this lack of control over your money is a big drawback—especially if you’re someone who likes to make decisions for yourself. It’s also worth noting that some people have legal questions about whether an annuity is even legal because of how it works.

Legacy Risk

Suppose you sign up for a fixed annuity that pays a lifetime income of $40,000 per year, and you’re going to be paid for the next 15 years. Then you die in your ninth year as an annuitant. Your beneficiaries will get virtually nothing because they inherit only the money left over from investing after nine years—not all of it! It’s important to understand that your beneficiaries could lose out if you die during the payout period. Some annuities will pay off a percentage of what was paid in, but others may not offer any death benefits at all and instead go back to whoever invested it originally (in this case—you). Furthermore, your beneficiary will have to pay taxes on the income leftover from an annuity.

High Surrender Charges

Most annuities will charge a significant penalty for withdrawing money too soon. If you have bought an indexed annuity, for example, and need to withdraw your money before the surrender charge period is over, you may have to pay a hefty fee. Surrender periods can be as long as 15 years.

Capped Return

Even if you sign up for a high-risk, high-return annuity and the market perform well, it’s unlikely that you’ll ever get a return as high as the one you could have gotten if you had invested in stocks. With the guarantee that your investment won’t go below zero comes the guarantee that it won’t go much above zero either. Insurance companies use caps and participation rates to limit the upside gains. For instance, if the market grows by 20% and your participation rate is at 70%, your return will be 14%.

Losses Are Not Tax-Deductible

Most investments, including IRAs and 401(k)s, allow you to deduct your losses. The IRS is not as forgiving when it comes to annuities. Suppose you have purchased a variable or indexed annuity and the return tanks. The IRS will expect you to pay taxes on that money, even though it’s absolutely a loss. Additionally, you can’t donate appreciated annuity income to charity and get a tax deduction for it. That stands in contrast to other investments, such as stocks and bonds.

Loss of Flexibility

With an annuity, you’re “locked-in” for the duration of your contract, which could be as long as 15 years. While that may not sound so bad for some people, the reality is that you cannot withdraw or change any of your investment allocations without incurring a penalty. Many people don’t want that kind of inflexibility or worry about being locked into an investment when something happens, such as a sudden drop in the market.

Commission

Lastly, annuities are sold by insurance agents, and they receive a commission based on the money they put into your account. Critics say this can lead to biased advice that may not be in their best interest or financial literacy for buyers who might not know any better. For example, an insurance agent getting a commission for selling an annuity to someone might encourage that person to invest a lot of money in it and not inform the prospective buyer of the drawbacks.

Frequently Asked Questions (FAQ)

Below are some of the most frequently asked questions about annuities.

How can I get my money back from buying an annuity?

During the initial phase of an annuity, an investor may have to pay a “surrender fee” in order to get their money back.  This fee is essential a reimbursement of the commission paid to the investor’s financial advisor.

Should I hold an annuity within my IRA?

No. It doesn’t make sense to invest an annuity with additional tax benefits within another account that already has the same tax deferral.

Why are annuities bad investments?

Annuities are often considered poor investments because many charge high fees and commissions while still exposing investors to significant market risk.

How do I cancel my annuity?

Canceling your annuity is the same as withdrawing all the money from it. That will incur a penalty, which may start at 7% and goes down to zero over the surrender period. The longer that you’ve had your annuity, the lower the penalty will be.

How long do I need to leave money in my annuity?

Each annuity is governed by its own rules, which are contained in the annuity contract.  The specific terms of your agreement will address how long you would be permitted to leave money in the annuity.

Should I Read the Contract or Just Believe What the Agent Tells Me?

Read it. It might sound like a lot of mumbo jumbo, but you’ll want to know exactly what your agent is offering and all the drawbacks so that you can make an informed decision before signing on the dotted line. Remember, insurance agents get a commission for selling annuity products so they might not be unbiased. Take everything they tell you with a grain of salt and read the small print.

The more you know about annuities, the better decision you’ll make when it comes to investing in one. U.S government’s regulatory authorities say they have received numerous complaints from customers who feel they were misled by agents selling them annuities.