ONE FAULTY INVESTMENT

I asked fee-only life-insurance adviser Glenn Daily, of New York City, to compare the purchase of mutual funds with buying the same funds inside a variable annuity. He assumed a $50,000 investment, earning 8 percent, for a buyer in the 30 percent tax bracket, with dividends and capital gains taxed at 15 percent.

Which worked better? (Drumroll, please.) The mutual funds, by a mile. Over more than 30 years, the fund investment outperformed the annuity both before and after tax. You also had access to your money, with no early-withdrawal penalties.

As for sales practices, you've got to hold your nose. The National Association of Securities Dealers brought more than 80 disciplinary actions against VA brokers over the past two years. Seniors are their particular prey, with 90-year-olds sometimes sold VAs whose withdrawal penalties last for 10 years or more.

To be fair, many brokers don't understand the product they're selling. But, still. A 90-year-old. In April the NASD proposed a special set of rules for policing VA sales practices. The question now is, can they pass? In a comment letter, the American Council of Life Insurers, a powerful lobby, ripped the proposals apart. (For more VA info, check the Investor Alerts at nasd.com.)

Once you've bought an annuity, you're potentially a sitting dupe. Within a few years your broker will probably suggest that you switch to another, "better" VA, in a tax-free exchange. If you bite, you'll pay another commission. You'll also have to hold the VA for many more years before you can touch your money penalty-free. In January the NASD brought an action against the Kansas-based broker Waddell &Reed for allegedly switching 6,700 customers to a new annuity that earned the broker higher fees. At least 1,400 folks were likely to lose money on the trade, according to the complaint, while W&R earned $37 million in commissions. W&R says its actions complied with all NASD regulations.

There's one little corner of the world where VAs might work, says annuity expert Moshe Milevsky of York University in Toronto. If you specifically intend to turn your VA into a future lifetime income, you might do well by buying now. But less than 1 percent of VA holders annuitize, which leaves the other 99 percent... where? Biggs says, darkly, that five years from now insurance execs will be marched, handcuffed, through courts to answer for the way they sell VAs today. It can't happen too soon.

REPORTER ASSOCIATE: TEMMA EHRENFELD

© 2004