What Are High Commission Variable Annuities?

The financial industry often uses terminology that may be unfamiliar to consumers, particularly those who are taking their first steps into the world of investing. One of these terms is “variable annuities” – in particular, high commission variable annuities. If you are an investor, you should understand what variable annuities are, how they differ from fixed annuities, and what financial risks they pose. If you lost money because your stockbroker of financial advisor recommended that you purchase variable annuities, the FINRA arbitration lawyers of Epperson & Greenidge may be able to help you get compensated. Read on to learn more about the dangers of variable annuities – and how an attorney can provide assistance.

What Are Annuities and How Do They Work?

Variable annuities are controversial in the financial community. Brokers and advisors often tout them as a way to guarantee income during retirement – but many wealth management experts have criticized them for a number of reasons, which our unsuitable investments securities fraud attorneys will explore in this article. However, before we can discuss the financial dangers of high commission variable annuities, we must first define what variable annuities are and how they work.

In general, an “annuity” is a financial product that creates a contract between an investor and an insurance company. Under this contract, the purchaser makes a series of payments, or in other cases, a single lump sum payment. In return, the insurance company agrees to guarantee disbursements, providing a reliable source of retirement income later in life.

Annuities are tax-deferred, which means the purchaser does not pay income tax on the annuity until he or she makes a withdrawal from the account. In fact, advisors often emphasize this aspect of annuities to make them more attractive to consumers.

Fixed Annuities vs. Variable Annuities

Not all annuities work the same way. There are two different categories of annuities: fixed annuities (also called “fixed-income annuities”), and variable annuities. Fixed annuities pay a certain amount over a set period of time, depending on your account balance. The rate of return may vary from year to year, depending on the insurance company.

Though these returns are generally modest, fixed annuities pose a low level of financial risk – significantly lower than that associated with variable annuities. This is due to the way variable annuities work. Unlike fixed annuities, which hold purchasers’ premiums in the company account for investment in various bonds, variable annuities invest premiums in mutual funds and stocks. If the stocks perform well, the purchaser could see high returns – but if the market encounters turbulence, the purchaser could lose money.

High Commissions and Other Risks of Variable Annuities

While variable annuities may offer opportunities to see high returns, the level of risk attached – among myriad other hazards and pitfalls – makes these contracts financially dangerous and ultimately, inappropriate for most investors. In fact, the very investors that variable annuities, promising retirement income, are most likely to target – the elderly – may be at the highest risk. As the AARP cautions, “The older you are, the less likely a variable annuity will be right for you.”

So what are some of the dangers of variable annuities? Four examples are discussed below.

Risk #1: High Commissions

As noted earlier, variable annuities earn high commissions for their sellers. The problem for investors is that these substantial commissions – which typically range anywhere from 6% to as high as 10% – are paid with the funds being invested. In other words, investors can automatically expect a 6% to 10% reduction of the funds they contributed.

To use an example, if an investor pays a premium of $50,000, the commission alone would eat anywhere from $3,000 to $5,000 of the funds, leaving a remainder of just $45,000 to $47,000 from the original $50,000. This commission is generally divided between the seller and the firm with which he or she is employed. Unsurprisingly, fixed annuities have lower commissions.

On a related note, high commissions are also problematic in an illegal practice called “trade churning,” where brokers generate commissions by making excessive trades.

Risk #2: Mortality and Expense Risk Charges

Other than the high commissions, variable annuities also draw criticism for the many fees they charge – for example, mortality and expense risk charges. This fee – which, as the U.S. Securities and Exchange Commission (SEC) explains, “compensates the insurance company for insurance risks it assumes under the annuity contract” – is typically 1.5% of the account value, to be charged annually.

Risk #3: Surrender Charges

Once you have made your contribution, prepare to wait – potentially, for as long as a decade. Why? Because you may incur costly penalties, known as “surrender charges,” by withdrawing from the annuity too soon following purchase. Depending on the company, the waiting period to avoid surrender charges is typically anywhere from six to 10 years. Surrender charges are generally up to 7% of the account balance.

Risk #4: Administrative Fees

Administrative fees create yet another set of costs for investors. Depending on company policy, the fee will typically either (1) equal approximately 0.15% of the account balance, or (2) will be charged as a flat annual fee, generally in the range of $30.

FINRA Arbitration Lawyers for Senior Investors and Fraud Victims

At Epperson & Greenidge, P.A., we are experienced financial negligence attorneys representing investors in FINRA claims against stockbrokers, brokerage firms, and financial advisors. When investors are financially victimized by brokers or advisors, our firm intervenes to fight for justice.

If your broker or financial advisor pushed you to invest in variable annuities in order to earn a higher commission, and you suffered serious financial losses as a result, we are here to help. Our FINRA attorneys can help you understand – and exercise – your legal rights. By filing a FINRA claim, it may be possible to recover compensation for your losses. To discuss FINRA arbitration in a free consultation, contact our law offices online, or call Epperson & Greenidge at (877) 445-9261 today.