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Deviled Nest Eggs

Long-term investments are not always a good option.

John and Carmen Migliaccio were looking for financial security in their retirement years. Their insurance agent said he had the answer: an annuity—essentially a form of retirement insurance that provides a regular, steady stream of income, much like Social Security.

So, at his urging the Migliaccios in January 2003 moved $43,000 from other investments into a tax-deferred annuity. But when John died in May 2004, just weeks shy of his 75th birthday, his widow learned the truth about their nest egg. The payments weren't scheduled to begin until January 2045—when John, who had endured several small strokes and was battling Alzheimer's, would have been 115 years old.

Carmen, as the beneficiary, now has access to money in the annuity account, but that's little solace. "We were counting on that money to help us get along in our retirement," says the Palm Desert, Calif., resident. "He was a sick man, and they took advantage of us."

"That's the typical scam," says Barbara Jones, an AARP senior attorney. Jones cautions that long-term investments are not a good option for many older people, who may need fast access to their money for medical care or other emergencies. Some kinds of annuities don't allow withdrawals for 15 years or more—and if money is taken out earlier, a hefty "surrender charge" can be as high as 22 percent on the amount withdrawn.

"These products are actively being sold to people 65 and older, but in many cases the stream of income they are promised doesn't start until after their life expectancy is over," says Claremont, Calif., attorney William Shernoff, who recently brought two class action lawsuits against insurance companies selling these products, charging that they dupe retirees of billions of dollars.

In February the California attorney general and the insurance commissioner sued several financial planning firms for luring older residents to free seminars that purportedly offered "expert" advice on living trusts and then peddling annuities to them. The Pennsylvania attorney general filed a similar lawsuit, and other states are investigating such practices.

So why are annuities so popular? They can be good investments because, in addition to paying a future steady stream of income, many are tax-deferred from the get-go, allowing savings to grow tax-free until withdrawn. (The bad news: Money is then taxed as ordinary income rather than as typically lower-rate capital gains.)

But annuities are also heavily marketed, to investors ofallages, because they reap higher commissions and other fees to those who sell them—sometimes four times higher than other types of investments.

"Whether you're buying from an insurance agent, or anyone else, the key is having someone who asks you about your wants and needs—and doesn't push a specific annuity or any other type of product," advises Steve Delaney of American Brokerage Services, Inc., a suburban Philadelphia consulting firm that evaluates annuities and other investments for financial planners and will soon begin publishing an annuities-advising newsletter for consumers.

Check with your state insurance commissioner or attorney general for past complaints (or make new ones) concerning annuities brokers; you can also file complaints with the NASD (formerly the National Association of Securities Dealers).

Some tips if you're considering an annuity:

Ask about penalty-free withdrawals. Delaney says many annuities allow investors at least a one-time opportunity to withdraw up to 10 percent of the account balance with no fees or penalties.

Inquire about shorter-term annuities. "You can buy an annuity that matures in five or six years, and some mature after three years," he adds. However, as with other investments, these shorter-term annuities usually offer a lower return-on-investment.

Consider age with opportunity. Variable annuities act like stocks, mutual funds and other "market-sensitive" products; their performance can widely vary, offering the promise of higher return—or bigger losses. "As a general rule," notes Delaney, "as you approach your senior years, less and less money should be in market-sensitive products."

Fixed annuities, meanwhile, are lower-risk investments that carry an interest rate that typically starts as a fixed percentage rate and then is adjusted annually. The come-on for these products is a high "teaser" introductory rate of return for the first year, says Adam Bold, chief investment officer of the Mutual Fund Store and host of a nationally syndicated radio show. "They may pay 12 percent in the first year, but then it goes to a floating rate, usually the minimum of about 3 percent—what you'd get with a CD."

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