EIAs should be securities

I find it unfathomable the way in which equity indexed annuities (EIAs) are marketed and sold to investors. In fact, while there are times when these products may be appropriate as part of a broad financial strategy, I believe the world would be better if they were never created. They are too often misused.

I have several issues with the way these products are created and the manner in which they are offered to consumers.

One major concern is that a “financial advisor” can recommend these products to a client without the advisor having any real knowledge of how the financial markets work. In fact, the advisor doesn’t even need to be licensed to sell securities. If someone has an insurance license, they can talk about how these products will provide the upside of the stock market while protecting the downside without understanding how these products are designed.

A consumer may believe they are engaging with a financial professional who has a myriad of options for which to recommend, when in reality, the financial representative has only one investment product – the annuity.

Second, EIAs typically have several years of surrender penalties. I’ve seen some contracts that tie up an investor’s savings for over 15 years. These surrender penalties are not in place because it takes several years for an annuity to “mature,” as some agents like to suggest. No, the surrender penalties are in place to reimburse the insurance company of the commissions paid to an agent should the investor cash in the account.

Third, EIAs are often sold as “no fees” to the investor. It’s true that an account owner would not see any fees deducted from her account, but that doesn’t mean there are not fees that reduce investor returns. The insurance company incurs a variety of costs, including overhead, marketing and sales, investment management costs and more.

Fourth, the commissions paid to the selling agent can create a tremendous conflict of interest. Just last week we had a caller on my weekly radio show / podcast whose mother was sold an EIA within two months of her husband’s death. This widow had little experience with investments and she had never owned an annuity (neither had her husband). A bank certificate of deposit was coming due and, rather than advise the widow to keep her money liquid during her time of mourning, the “financial advisor” took the majority of her cash and put it into an annuity with a seven-year lockup.

Sorry, but there is now way this agent would have done this to a widow had it not been for the big commission payout.

Fifth, the tax deferral of annuities can be detrimental to many investors. Yes, the earnings are taxed deferred, but any gain in the contract will be taxed as ordinary income as opposed to capital gains. Further, unlike most other investments, the account will not receive a stepped-up basis upon death.

Equity Indexed Annuities need to have the same level of regulatory oversight as other investments. It’s time for them to be treated as securities.