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Was my mom conned?
Per adviser, my mom put all her money into an aggressive growth variable annuity IRA, which tanked.
August 11, 2005: 11:32 AM EDT
By Walter Updegrave, CNN/Money contributing columnist

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NEW YORK (CNN/Money) - When my mom was 54, just divorced and looking invest for her retirement, she took $110,000 (about 80 percent of all the money she had) and on the advice of an adviser put it all into an aggressive growth variable annuity IRA. The value of that account subsequently dropped as low as $50,000, although it has since rebounded to about $76,000.

My mother has little or no earning power, so she's depending on this money. Do you think this investment was an improper choice for her or was this just a case of bad market timing?

-- Steven, Spring, Texas

I don't have all the facts of your mother's financial situation, so I don't want to jump to the conclusion that your adviser did something unethical or stupid or both. But based on what you've told me, however, I have serious doubts about this recommendation, and I can't help but wonder if the adviser was putting his or her own needs (i.e., the need for a commission) ahead of your mom's.

Troubling recommendations

Basically, I find the recommendation troubling in two ways. First, there's the issue of putting the money into an IRA annuity. Essentially, an IRA annuity is a vehicle that some advisers -- often insurance agents, but also brokers and financial planners -- use as an investment vehicle when moving money from a tax-deferred savings plan such as a 401(k) or another IRA. It's really nothing more than buying an annuity of some sort and putting it inside an IRA.

In your mother's case, it appears that the type of annuity she got was a variable annuity -- that is, one that allows her to invest in "subaccounts" that operate pretty much the same as mutual funds. A big selling point of variable annuities is that the income and gains within these subaccounts is not taxed until the money is withdrawn from the annuity.

So if investment income and gains within the annuity are sheltered from taxes why would I have a problem with such an arrangement?

Simple. You don't need the annuity. You can get the same tax shelter merely by putting the money into a mutual fund within the IRA rollover account. So the annuity is redundant. You're already getting tax deferral within the IRA, so there's no need for the variable annuity.

Now, that redundancy might not be a problem, except for one thing: variable annuities tend to have much higher fees and expenses than mutual funds. In addition to the regular annual management fees that mutual funds charge, variable annuities also levy certain "insurance charges" that often run 1 percent or more of assets. Add these insurance charges to management fees and variable annuity owners can easily face annual charges of 2 percent or more of their assets.

Variable annuities also carry what are known as "surrender fees." These fees, which can range as high as 10 percent (although 6 percent or 7 percent, are levied if you cash out of the annuity early on. These fees do decline and eventually disappear if you hold the annuity long enough -- usually 7 to 10 years -- but they can make it expensive if you decide you want to move your money elsewhere.

Variable annuity fans argue that there are other benefits that compensate for these higher fees. But I don't think they make a convincing case. To me, it rarely makes sense to move money that's already in a tax-deferred account such as a 401(k) or IRA into a variable annuity.

One exception might, I stress might, be if someone plans to "annuitize" the money in the annuity soon -- that is, turn the account balance into an income stream that can last for life. But even if creating a lifetime income is one's aim, I believe it's better to wait until you're ready to draw on that income before buying the annuity rather than do it many years in advance.

Besides, while using an annuity to create a lifetime income can be a reasonable move, you've got to keep in mind that by "annuitizing," you restrict your access to your money. So you don't want to annuitize too much of your nest egg, otherwise you may not have a large enough stash of money available for life's little emergencies and unforeseen demands. For more on the pros and cons of creating lifetime income with annuities, click here.

One fund is not very diverse

The second aspect of the recommendation I have trouble with is the fact that your adviser apparently put a huge chunk of your mom's net worth in just one fund, and an aggressive growth fund at that. Why the adviser wouldn't have spread that money among several different "subaccounts" representing a variety of asset classes and investing styles -- stocks and bonds, large stocks and small stocks, growth and value -- is beyond me.

Again, I don't have all the facts at hand. But it's hard to imagine a case for not diversifying your mom's portfolio, especially if this money represents a huge portion of your mom's investable assets.

If I were you, I'd first talk to your mother to get her take on what happened with this adviser. Did she understand what she was getting into? Did she realize the risks in concentrating her money in an aggressive growth account? How did the whole idea of the annuity come about? What was the purpose of it?

If that conversation leaves you feeling that your mother was essentially steered into the annuity and the aggressive fund without any real understanding of the purpose of the investment and its inherent risks, I'd move on to the adviser and his or her supervisor. If after hearing their side of the story you and your mom feel the recommendation wasn't appropriate, I'd consider complaining to the regulators.

In a case like this, there are several different regulators that could have jurisdiction, so I'd file complaints with the Securities and Exchange Commission, NASD and your state insurance department.

One final note: I'm not one of these people who feels that any time an investor suffers a loss that an advisor is automatically at fault. Even the best recommendations can run up against the shoals of a market meltdown or a major change in financial conditions.

So a loss doesn't necessarily reflect greed or incompetence. But there are enough little oddities in your mom's case to justify a closer look on your part and, depending on what you find, possible follow up with the authorities.

Walter Updegrave is a senior editor at MONEY Magazine and is the author of "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."  Top of page


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