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Why annuity sales have skyrocketed

Ask most financial planners about annuities as an investment strategy and you'll probably get a look that resembles the first whiff of bad cottage cheese. Don't even go there.

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But then you look at the sales of both fixed and variable annuities and they're through the roof. Between 1989 and 1999, the American Council of Life Insurers reports that premiums on annuities more than doubled from $49.4 billion to $115.6 billion.

An annuity, if you're not familiar with them, is an insurance contract that's best used -- and most often marketed -- as a means of tax-deferred savings for retirement. The money in an annuity isn't taxed until it's withdrawn.

There are several kinds of annuities, but the bulk of them are either fixed, which means there is a guaranteed rate of return, or variable, which have a return tied to the performance of the underlying investments.

A Forbes special report on variable annuities, citing research from Variable Annuity Research and Data Service, noted that the industry reached a milestone last year when assets passed the $1 trillion mark and that annual sales grew by 1,200 percent over a 10-year period.

Buying and selling
So, what gives? If annuities are such a bad deal, why do people keep buying them even though financial planners don't care much for them?

One of the major reasons for the steady increase in sales, the financial advisers say, is that annuities have very nice sales commissions.

"People aren't buying them; they're being sold," says John Sestina, a fee-only certified financial planner in Columbus, Ohio. "That's not to discredit an insurance person, but right now, there are people making a living selling annuities."

On the Web site FundAdvice.com, Paul Merriman cites typical commissions of 5 to 5.5 percent of the money invested, with some contracts paying up to 14 percent commissions. And unlike commissions on mutual funds that go down at certain break points as the account balance increases, annuity commissions go up right along with the balance.

Also, while the numbers look very impressive, you need to understand a little about how the numbers are reported, says John Wesley, product manager of personal annuities for TIAA-CREF, short for Teachers Insurance and Annuity Association and College Retirement Equities Fund.

While virtually every other investment reports net flows, "the annuity industry for years reported just on gross sales," he says.

It's an important distinction because many of those sales are actually assets that have been moved from one fund to another under what's known as a 1035 exchange, a provision in the tax code that allows people to take money out of one tax-deferred investment and put it in another one without paying any taxes or penalties.

"When a contract is surrendered, Company B picks it up as a sale, but Company A didn't report it as a loss," he says. "If you look at research data like Research Insight, a good 50 percent is probably 1035 money moving around."

An underlying reason behind the transfers, Wesley notes, is once again, commissions.

"As these things come off surrender charges, if I can convince you to move from one company to another, it generates another commission," he says. "The Securities and Exchange Commission is very sensitive to that right now. They're taking a hard look to make sure (insurance companies) are not churning these accounts. It's not always in the consumer's best interests."

 
 
Next: "Sales are down dramatically."
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