Insurance companies pay annuity salesmen large commissions. Typically, these range from 3 percent to 8 percent depending on the type of annuity sold. Unfortunately, these large commissions encourage unscrupulous salespeople to sell annuities when they are inappropriate or even to engage in outright scams. Usually the type of annuity sold is a single premium deferred annuity. Not all persons who sell annuities do so inappropriately, but many otherwise reputable institutions, such as banks, insurance companies, and financial planners, do sell annuities in inappropriate situations. Perhaps they need to ask the question as to whether the annuity is appropriate or is the commission driving the sale. Some annuity salespersons fail to disclose that income received by a Medicaid recipient from an annuity will be paid to the nursing home. They usually fail to disclose that there will be an attempt at estate recovery in those states which have estate recovery against annuities. Some long-term care insurance salespersons who sell annuities for the purpose of providing a funding source for the LTC premiums fail to disclose that the payments from the annuity will result in tax liability as to the income portion. Some annuity salespersons encourage clients to withdraw money from the clients IRA to buy an annuity outside the IRA and fail to disclose the tax consequences of the withdrawal. Some annuity salespersons discourage clients from purchasing long-term care insurance by promoting the purchase of an annuity and claiming that the annuity will protect the clients assets.

INCOME DEFERRAL
The principal reason for persons to purchase deferred annuities is to defer the tax on the income earned until later years. It makes great sense if a 55 year old person at the peak of his or her earning years purchased an annuity for a term of 10 years with the idea of deferring the income until after he or she retires and will be in a lower income bracket. It makes much less sense for an 80 year old retired widow in a 15 percent tax bracket to purchase a deferred annuity with the idea of deferring income until a later date. What often happens is that the deferred income accumulates and is taken out in a lump sum and tax is paid at a rate much higher than the initial 15 percent tax rate.

Unlike stock which receives a step up in basis on the death of the shareholder, there is no step up in basis for the income which has been accumulated in a deferred annuity. Eventually this income must be paid out and the tax must be paid. The longer the income accumulates, the larger it becomes and the larger the ultimate tax bite.

If a client purchases a diversified portfolio and holds it for one year, the maximum capital gains tax rate is 20 percent. However, if the client purchases the same assets in a variable annuity, the tax on the capital gains is deferred until the funds are withdrawn from the annuity, but when the money is withdrawn, it is subject to ordinary income tax rates in many cases. For a 40 percent taxpayer, the capital appreciation is reduced to 60 percent. If he had invested directly in equities and paid 20 percent capital gains tax, he would have benefitted from 80 percent of the capital appreciation. According to Phillip M. Lindquist, Esquire, if one assumes expenses of 0.75 percent, that would have to be paid out of capital appreciation and the capital appreciation averaged 13 percent, the variable annuity would have to be held for at least 30.7 years for the variable annuity to equal the performance of a comparable equity portfolio held outright. Capital appreciation in the 13-14 percent range is supported by historical data.

Assets held in an equity portfolio result in a step-up in basis on death. Payments under an annuity contract following the death of the owner are essentially taxed the same as income in respect of a decedent. All the payments received in excess of basis are ordinary income. The step-up in basis is lost.

AGE OF ANNUITANT
In determining whether or not an annuity is an appropriate vehicle the age of the purchaser/annuitant must be considered. If a person in their 80s purchases an annuity which carries surrender charges for a period of 7 years, this would appear to be a very beneficial arrangement to the insurance company resulting in a significant commission to the salesman, but an inappropriate investment vehicle for the individual.

QUALITY OF INVESTMENT
A Forbes magazine cover warned: Don't be a Sucker* Variable Annuities are a Lousy Investment. The magazine concluded variable annuities are sold not bought. Fees and expenses incurred with a variable annuity reduce the investments total return. These vary considerably from one contract to another, but they are generally high. Annuities are generally sold on the basis of the benefit of tax deferral. If a variable annuity is invested in stock, the income produced is low. The average dividend on stocks comprising the Standard and Poors 500 Index is approximately 1.5 percent. Assuming an investor in a 40 percent tax bracket, the deferred annuity would save .6 percent. The annual expenses in connection with the annuity average approximately 1.25 percent. The investor is usually better off simply purchasing the equities.

THE FREE MONEY
Insurance companies are now selling annuities with free money. The insurance company markets the annuity as follows. An investor who pays $100,000 for an annuity will receive a bonus of 3, 4 or 5 percent. The money is not free. The investor pays back the bonus in higher fees over the life of the investment. If a company is paying a bonus of 3 or 4 percent and they're paying a sales commission of 3 to 8 percent, that money has to come from somewhere, says Jon A. Boscia, Chief Executive of Lincoln National Corporation, a company that does not pay bonuses. Additionally, investors are often required to tie up their money for nine years, rather than the typical seven years. Surrender charges for this type of annuity can be as high as 8.5 percent, which is 1.5 percent higher than the typical penalty.

ANNUITY SCAMS
There are companies that operate on a local or even national basis that engage in very aggressive marketing activities to sell annuity products. These are not usually insurance companies, but rather agencies or networks of agents selling insurance products. They often establish a name including the word senior which can be misleading because it can be construed as a non-profit organization. These organizations then conduct marketing seminars under the guise of educating the attendees about financial issues affecting senior citizens. The advertisements often contain scare tactics and false and misleading information. While much of the underlying information is truthful, it is often presented in a sensational manner. It is often calculated to scare the senior citizen into purchasing an annuity. The income tax benefits of deferring income are usually exaggerated, the surrender charges for early withdrawal are usually glossed over if mentioned at all, the appropriateness of the annuity for the age of the purchaser is rarely discussed, and the attendees are informed that the purchase of the annuity will help protect the asset from subsequent claims of a nursing home. The details as to how the annuity needs to be structured for Medicaid eligibility are rarely mentioned. The disadvantages of annuity ownership are never raised.

CONCLUSION
While the authors are strong proponents of the use of annuities in Medicaid planning, we believe that they are a last resort, not a first choice. Because of the significant disadvantages to annuities, they should be considered only after there has been a thorough analysis of the clients facts and circumstances and other Medicaid planning options have been thoroughly explored. Annuity salesmen conducting the seminars under the guise of educating senior citizens do not mention alternative Medicaid planning strategies. Elder law attorneys need to be vigilant in advising seniors with respect to the purchase of annuities. We should also support greater regulations of the sale of annuities to those over age 65.