Annuity Pitches Can Mislead Older Investors

Elder-law attorney Ed Long has a rather radical proposal to help protect seniors from unscrupulous insurance peddlers. He wants the state Legislature to require that all annuity sales to people older than 60 be reviewed and approved by an independent advisor before the sale can become final.

Why such a review? Because too many people are trying to induce older Americans to buy unsuitable annuities, which are insurance contracts with tax-deferred investment features. Regulators and financial planners point to the growth of annuities that are often sold in the guise of estate planning and to seminars that push annuities as a way to qualify for Medi-Cal, the state and federal health program for the poor.

“These salesmen hold ‘public information’ seminars to talk about long-term care costs and give only half of the picture,” said Long, executive director of the nonprofit Healthcare & Elder Law Programs Corp. in Torrance. The annuity pitches “mislead people into buying annuities that are unsuitable, ill-advised and inappropriate for their situations.”

Annuities can have a legitimate role in financial plans, and indeed annuity sales are booming. An estimated $164-billion worth were sold last year, triple the number of a decade ago. The majority were variable annuities, retirement saving vehicles that allow tax-deferred investments in a mix of stocks, bonds and cash. The rest were fixed annuities, which guarantee an interest rate for a certain length of time.

The problem comes when annuity buyers don’t fully understand the drawbacks.

Some insurance salespeople, as well as some of Long’s elder-law peers, encourage people to buy fixed annuities as a way to skirt Medi-Cal’s income and asset limitations and qualify for coverage.

Medi-Cal, or Medicaid as it is known in other states, is the only government program that pays for most custodial nursing home care. Certain kinds of carefully structured fixed annuities can indeed legally turn assets that might otherwise disqualify an applicant into an income stream that might be exempt from Medi-Cal rules. The rules are complex, but suffice it to say there are many drawbacks to the annuity approach that a commission-based salesperson might not bring to the older person’s attention.

For example, annuities can be costly, with higher fees than comparable investments and significant surrender charges. Also, seniors who buy these annuities often lose inflation protection, because the investments may grow too slowly to protect buying power. Investors also lose flexibility, because it can be difficult or impossible to get money out. Annuities have some tax disadvantages along with their tax advantages; unlike stock, bond or mutual fund investments, income from annuities is not eligible for capital gains rates and is instead taxed at higher income tax rates.

In addition, some salespeople encourage seniors to cash in other investments or withdraw money from retirement accounts to buy the annuities, actions that can create a huge tax bill, Long said.

Then there is the question of whether people who can afford to pay their own way should be trying to qualify for Medi-Cal in the first place.

Some advocates of Medi-Cal planning insist it’s a smart way to ensure a hard-earned nest egg isn’t depleted by nursing-home costs.

Critics question the ethics of deliberate impoverishment and say seniors make a bad trade when their desire to leave an inheritance causes them to give up financial flexibility. Although nursing homes are required by law to treat Medi-Cal and private-pay patients the same, many of the best homes do not accept Medi-Cal patients, and Medi-Cal does not cover the cost of care in the patient’s home, which is where many seniors would prefer to stay.

No one knows how many “Medi-Cal annuities” are being sold. But California state officials consider the sales a serious enough threat to the program’s viability that the Department of Health Services is drafting regulations that would help the state get back some of the money that seniors are trying to keep, said Lea Brooks, department spokeswoman. One proposal would require any money left in the annuity at the patient’s death to be forfeited to the state, she said.

The state already recovers about $40 million a year from Medi-Cal patients’ estates, largely by making claims against their homes after their deaths. It’s a drop in the bucket; Medi-Cal’s budget is more than $22 billion a year.

Medi-Cal annuities aren’t the only kinds of annuities being pushed to older Californians. Regulators have targeted so-called living-trust mills that sell annuities under the guise of estate planning. Many sell living-trust kits to seniors and then use the financial information gathered to sell high-priced annuities. Before state regulators stepped in in 1996, for example, Lake Forest-based Alliance for Mature Americans sold more than 9,700 annuities to seniors, sometimes using sales pitches that lasted as long as eight hours. The company agreed to a $1-million fine, while insurance companies that provided the annuities agreed to refund more than $130 million to its customers.

Even banks are now pushing annuities to customers looking for alternatives to certificates of deposit. Unfortunately, another significant drawback of annuities is that they don’t get the special tax treatment known as a “step-up in basis” at death; financial planners say this often is not explained to bank customers.

Laura Tarbox, a Newport Beach financial planner, said one of her clients was sold $29 million in annuities when his main purpose was to leave the money to his heirs. “We’re still trying to figure out what we’re going to do,” Tarbox said.

Long bases his proposal for a mandatory review of annuity sales on a law passed in 1993 that requires an independent analysis and special certification if an estate planning attorney is included as a beneficiary in someone’s will. That law came about after a series of articles in The Times revealing that a Laguna Hills attorney, James D. Gunderson, had reaped millions after being named in several clients’ wills.

Whether or not Long’s proposal ever becomes law, investors should heed his warning. Annuities are complex investments with significant potential disadvantages. Anyone, young or old, who is considering an annuity would be smart to get an unbiased second opinion before handing over any cash.

*

Liz Pulliam Weston regrets she cannot respond personally to queries, but questions of general financial interest may be sent to her at [email protected] or mailed to her in care of Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Annuity Explosion

Annuity sales have grown dramatically in the last decade as investors seek--or have been sold on--their potential tax and estate-planning advantages.

Annuity sales, in billions:

*

1999 (estimated): $119.5 billion in variable annuities, $44 billion in fixed annuities

*

Source: Limra International