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Earn 7.2% By Sending Your Money to Prison

In an era of 2% CD rates, the offer stood out: 7.2% for the first year; 4.7% for each of the following nine years.

It took three phone calls and an in-person visit to figure out the catch. The first year rate was real; the rates for the following years were not. Yet you'd get slammed with very real penalties if you fled when you figured that out.

When a fixed-rate isn't fixed

Such are the challenges of buying fixed-rate annuities.

These products can seem simple and compellingly attractive in uncertain times like these, but annuities are more complex than they seem.

They shouldn't be summarily dismissed because they're valuable for some buyers. Anyone who bought a fixed-rate annuity in the past year, for example, is probably crowing about their positive returns, while most investors have been suffering double-digit losses.

Unfortunately, too many people buy annuities based on big-print promises that are taken away in the tiny type of the terms and conditions. Those who don't read this fine print can end up disappointed before they're kicked in the teeth with surrender fees and tax penalties when they try to bail out.

A closer look
Let's look more closely at this annuity to illustrate what you need to know before you buy.

This product, promoted in a prominent advertisement in the Los Angeles Times, is called the Platinum Bonus 10 annuity, offered by AAA Life Insurance of Livonia, Mich. The bold print screamed "great rates for a limited time." But beneath the interest rate promise was a dense paragraph of vague caveats.

I called the number in the advertisement to get more detail. The crux of it: The product is a 10-year annuity, paying 4.7% annually. But policyholders get a bonus of 2% or 2.5% in the first year, bringing that rate up to 6.7% or 7.2%, depending on how much you invested.

Was the 4.7% guaranteed? "Absolutely," the salesman assured me. "Great," I responded. "Could you send me the contract, so I can see that in print?" Now it was his turn to act confused. Contract? What contract? Did I mean the application?

Always check the paperwork

A word of warning, gentle reader, insurance companies never provide guarantees without contracts which allow them to add conditions under which they can weasel out of the guarantee. If they say there's no contract, there's something seriously amiss. I insisted that he email the contract before I consider the investment further. I never heard from him again.

I called again and got the same response, including the unfulfilled promise to email the contract.

I finally visited a local office, where a friendly salesman corrected the phone representives' guarantee claims. Actually, he said, the 4.7% rate was not guaranteed at all. The guaranteed rate noted in the sample contract that he ran out for me was 1.5%. He said that the 1.5% was incorrect. The real guaranteed rate would be 2% and would show up in a real contract, as soon as I agreed to buy.

Rate roulette?
Of course, 2% is a pretty miserable return and less than half the 4.7% that the advertisement promised. Even in today's rotten rate environment, you could get a 3% rate with a five-year bank CD and have your money locked up for half as long. The annuity salesman contended that I shouldn't worry. Regulators require them to tell customers about the 2% guaranteed rate and show it in illustrations, but they never pay that, he claimed. They always pay more. (Sorry to be a cynic, but this reminded me of the FDA, which requires makers of impotence drugs to add those kill-joy caveats about potential side-effects, including death, as we see the happy couple dancing off to their hotel room. Why must they disclose this? Mainly because of the deaths, I think.) But, then, annuity sales tactics are notorious.

Fee to flee
Okay, so let's say the worst happens and you get just the guaranteed rate. You don't lose money. You just get a lousy return. But you're stuck with that lousy return for a really long time. The reason: This is a 10-year contract, which charges you a "surrender" fee if you bail out early. The surrender fee starts at 10% of your account value in the first year and steps down by one percentage point each year.

That's just like an early withdrawal penalty that you'd pay if you took money out of a bank Certificate of Deposit, the AAA salesman said. True, but with one big difference. If the bank says it's going to pay 4.7% for 10 years, it does. It doesn't give itself the right to cut the rate in half, but still keep you locked in with an early withdrawal penalty.

Tax penalties too
There's one last problem with the annuity. Putting your money into an annuity is the same as putting it into a qualified retirement plan. The good part about that is that the money earned within the account is not taxable until you withdraw it. The bad part is that if you withdraw before retirement age (59.5), you could be subject to both taxes and tax penalties.

All of this (except the sarcasm), is in the contract. Read--and read carefully--before you buy.