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FLORIDA COURT HITS MERRILL LYNCH WITH $7.75 MILLION JUDGMENT FOR IMPROPER ANNUITIES SALES
by Lawrence C. Melton, Esq.
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(November 19, 2007 - Monday) - November 19, 2007
FLORIDA COURT HITS MERRILL LYNCH WITH $7.75 MILLION JUDGMENT FOR IMPROPER ANNUITIES SALES
by Lawrence C. Melton, Esq.
THE HAYES LAW FIRM, www.dhayeslaw.com, phone 713-862-2152, toll free 1-866-332-3567
A jury trial in Palm Beach County Florida issued a $7.75 million judgment against Merrill Lynch last month in a case involving the sale of annuities. In 1995, broker Karen McKinley began selling what would eventually total $32 million worth of annuities to well-known builder turned philanthropist, George Rothman. The issue in the case was non-disclosure and fraud. McKinley told Rothman that the annuity contained no fees, sales charges or commissions. The jury verdict was for $6 million. At the start of November the jury awarded an additional $1.75 million in punitive damages. (Bruce Kelly, ...But bad news rolls on: $11M bite in 2 lost cases, InvestmentNews, Nov. 19, 2007).
http://www.investmentnews.com/apps/pbcs.dll/article?AID=/20071119/REG/711190341
Generally speaking, variable annuities have high fees, low flexibility and horrendous tax treatment. They are sold based on insignificant tax or insurance benefits by registered representatives with strong financial incentives adverse to those of their clients. According to FINRA (then known as NASD):
NASD has become increasingly concerned about some members' unsuitable recommendations and inadequate supervision of transactions in deferred variable annuities...[C]ertain firms continue to engage in unacceptable sales and supervision practices regarding these products. For instance, variable annuity sales have been the subject of more than 80 NASD disciplinary actions in the past two years. These disciplinary actions involved a wide array of misconduct regarding the sales of variable annuity products, including excessive switching, misleading marketing, failure to disclose material facts, unsuitable sales, inadequate training and supervision of salespeople and deficient written supervisory procedures."
NASD NTM 04-45 http://www.finra.org/RulesRegulation/NoticestoMembers/2004NoticestoMembers/P003008
A broker and brokerage house must have reasonable grounds for believing that a variable annuity is suitable for the particular individual customer. NASD NTM 96-86http://www.finra.org/RulesRegulation/NoticestoMembers/1996NoticestoMembers/P004696
Deferred variable annuities are designed as retirement savings vehicles. With variable annuities you are not supposed to withdraw the money until you retire. You are supposed to open a variable annuity well ahead of retirement age, watch the annuity accumulate gains, and then begin withdrawing the money twenty or thirty years later when you retire.
The government does not want you to run out of money before you reach retirement age. So, there is a 10% federal tax penalty if you withdraw money before age 59 and 1/2. In addition, the annuity company charges the investor "surrender charges" when he or she withdraws money from a variable annuity before a specified period. Surrender charges usually start at around 7% of your investment and decline to zero over the next eight years or so.
• If your investment is short-term, you should not be in a variable annuity.
• If you have an immediate need for retirement income and living expenses, you should not be in a variable annuity.
• If you require frequent withdrawals, you should not be in a variable annuity.
It is always improper for a broker or financial planner to recommend variable annuities to an elderly individual. Most retired individuals currently invested in variable annuities will not live long enough to see the benefits outweigh the costs. This is because they opened the variable annuity too late in their life. Variable annuities lack liquidity. The surrender charge and early withdraw penalties guarantee that the elderly investor will be locked up in the variable annuity for a number of years.
The main benefit of a variable annuity is tax deferral, which means the earnings that accumulate in an annuity are not taxed until withdrawn. The potential for tax-deferred growth is almost always offset by (1) higher fees and surrender charges and (2) higher taxes. You have to hold the annuity for a long, long time before the benefit outweighs the costs. Before investing in a variable annuity, please consider the following:
1. An investor must hold a variable annuity for a long period of time--ten to twenty years--before the tax benefit will outweigh the exorbitant fees.
2. Gains earned in a variable annuity, however, do not qualify for the lower capital gains tax treatment. The variable annuity converts capital gains into ordinary income for tax purposes. The investor will usually have to hold the annuity for years before reaching the break-even point when the benefit of deferral catches up with the detriment of converting capital gains to ordinary income.
The fees imposed on variable annuities are considerably higher than those imposed on mutual funds and other alternative investments. An investor must hold a variable annuity for a long period of time--ten to twenty years--before the tax benefit will outweigh the exorbitant fees. According the NASD NTM 04-45, variable annuities subject investors to the following fees or charges.
o Surrender Charges: paid by investor when he or she withdraws money from the annuity before a specified period.
o Management Fees: assessed against the sub-accounts.
o Mortality and Expense Risk Charge: charged by the insurance company for the insurance risk it takes under the contract.
o Administrative Fees: charged for record keeping and other administrative expenses.
o Underlying Fund Expenses: relating to investment options.
o Charges for Special Features and Riders: e.g., provisions for stepped-up death benefit or a guaranteed minimum income benefit.
The added expenses associated with variable annuities cannot be justified unless the annuity is held for an extended period of time. It follows that variable annuities should not be sold to individuals who are retired or close to retirement.
A similar problem in the tax treatment of gains in the variable annuity. Capital gains typically qualify for a lower tax rate than income. Gains accumulated in mutual funds and stocks qualify for the lower capital gains tax treatment. Gains earned in a variable annuity, however, do not qualify for the lower capital gains tax treatment. The variable annuity converts capital gains into ordinary income for tax purposes.
A deferred variable annuity is thus a double edged sword: your gains grow tax deferred, but you lose the lower capital gains tax treatment. The investor will usually have to hold the annuity for years before reaching the break-even point when the benefit of deferral catches up with the detriment of converting capital gains to ordinary income.
Registered representatives rarely disclose the following: (1) that withdrawals from the variable annuity will be taxed as ordinary income, even if they are capital gains; (2) that capital gains are taxed at a lower rate than ordinary income; (3) that withdrawals from mutual funds have the potential for long term capital gains tax treatment.
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THE HAYES LAW FIRM, www.dhayeslaw.com
phone: 713-862-2152, toll free: 1-866-332-3567
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