Heightened Risk of Sales Practice Violations With Sales of Variable Annuities
The SEC and FINRA recently issued their 2016 exam priorities. Both regulators identified sales-practice violations relating to variable annuities as priorities.
According to the SEC’s Office of Compliance Examinations and Inspections (OCEI), the 2016 exam priorities “reflect certain practices and products that [it] perceives to present potentially heightened risk to investors and/or the integrity of the U.S. capital markets.” Regarding variable annuities specifically, OCEI stated that it plans to assess the suitability of sales of variable annuities and the adequacy of disclosure and supervision of such sales.
In addition to facing scrutiny from regulators in 2016, brokerage firms that sell variable annuity products can also expect to face claims by individual investors in FINRA arbitration proceedings. Last year, approximately 5% of the customer claims that were filed with FINRA involved variable annuity products. The primary complaint in most variable annuity cases is that the investment was not suitable for the customer, based on the customer’s unique investment profile, and/or that the broker did not adequately disclose all of the material risks associated with the investment. In many cases, the broker puts his own financial interests ahead of the investor’s best interests. The broker’s commission on a VA sale could be as high as 5 to 8%.
Some general observations can be made regarding variable annuities and the suitability of such investments. First of all, variable annuities are long term investments. They address the risk that an investor might outlive his wealth by providing the investor with a stream of income for the rest of his life, or for a specified period of time. Once the investor’s funds are committed, they generally cannot be withdrawn without incurring substantial “surrender” charges. In addition, a penalty tax is applied to any withdrawals taken prior to age 59-1/2. Based on the foregoing, variable annuities are generally not suitable for investors who have short investment time horizons and/or significant liquidity needs.
Those who sell variable annuities often tout the “death benefit” feature and “tax advantages” as reasons for investing in variable annuities. Both claims deserve close scrutiny. The death benefit is only paid if the investor dies before the annuity begins paying out. In that instance, the beneficiary typically receives an amount equal to the amount that was contributed by the investor or the contract value, whichever is greater. The death benefit is not the equivalent of traditional life insurance and is generally not a suitable alternative to traditional life insurance. The main tax advantage of variable annuities is that they offer tax-deferred growth. Qualified retirement plans offer the same benefit, but also have the added benefit of reducing current taxable income. In most cases, it makes sense to maximize contributions to 401(k)s and other tax-advantaged retirement accounts before investing in annuities. Also, tax-deferred does not mean tax-free. When payments are eventually made under an annuity, the earnings are taxed at the ordinary income rate, not the capital gains rate.
Need Assistance?
If you have suffered investment losses as a result of malpractice or misconduct our experienced team of investment fraud attorneys may be able to assist you in recovering some or all of your losses. Call us toll-free at 1-888-607-4819 for a free consultation or email us through our “Contact” page to schedule a free consultation.