Consumer Safety & Awareness Part 10

Bait & Switch: Financial and Service Scams

How would you react if a store keeper took your five-dollar bill and gave you a single in exchange? Some financial institutions use bait and switch to increase their profits, and, based on their reactions and refusal to admit there is anything wrong with their practices, they simply do not care.

Every time a company attempts to sell an annuity, they are pulling a scam. Annuities have the worst rate of return of any investment, and by telling you otherwise, in fact by assuring you that it’s the best investment you can make, the salesperson as well as the company is lying to you. By not offering an investment that has a higher rate of return, they are using a variation of bait and switch.

USA Today offers this advertisement as an example: "Come learn from the IRA Technician" at a seminar that more than 10,000 seniors have attended. Top sirloin steak will be served — along with tips on "how to guarantee your IRA will never run out, regardless of market fluctuations." The seminar then attempts to sell you an annuity. Since it takes forever for annuities to pay off, those over 50 should never invest in them.

When I was teaching, I was offered annuities almost every year. Many of my fellow teachers actually invested. Today, partly because I refused to invest in them, I have more money than they do.

An annuity is an investment that is tax deferred. You put in an amount, usually it’s taken out of your pay check and any interest you earn is not taxed until you cash it out, usually when you retire. Annuities are poorly regulated, and the companies are not required to disclose everything to you. They actually produce the lowest return of all legal investments. Many of them not only have large, occasionally hidden fees and commissions, but also take a percentage of your earnings out for maintenance or other silly excuses. Even Fidelity Investments, one of the most trustworthy names in the industry, was cited for annuity fraud.

It is highly recommended, based on more than 30 years of investigation by lawyers and consumer advocates, that you never put any money into an annuity and if you have money there you should consider withdrawal as soon as you can, even if it creates a penalty. A typical municipal bond fund, which is mostly tax-free and has consistently returned over 3%, occasionally up to 5%, produces as much as five times the return of an annuity.

The following information is from infofaq.com: “Variable annuities cost too much. Because annuities are primarily insurance products, their fees typically dwarf those charged by mutual funds. This is simple to understand when you realize there are two players involved instead of one.....the insurance company and the mutual fund company. According to Morningstar, the average variable annuity passes along expenses of 2.2 percent of the assets per year. This percentage probably won't mean much to you unless you realize how such a large fee can drain the momentum out of a portfolio. Let’s suppose, for example, that you invested $3,000 a year in a typical variable annuity that generates a yearly and unbelievably large 8 percent return before expenses. At the end of a 25-year period, your annuity would have grown to $168,000. If you had put that money into tax-efficient index mutual funds, charging between a low of 0.20 percent and a high of .50% in yearly expenses, the index fund would be worth $230,000. That's a difference of $69,000.”

Salesmen love to boast that you won't pay taxes on the money that's growing inside an annuity, because it’s "tax deferred". That's true, but it’s only half the story. You'll owe ordinary income taxes on every dollar of annuity withdrawals. This might not seem so bad until you appreciate what would happen if you had invested the same money in stocks or mutual funds in a plain old taxable account. These withdrawals would be taxed at long-term capital gains rates, which is only 15%. So lets say you're in a 35% ordinary income tax bracket and you've got a variable annuity. You'd pay $350 in taxes for every $1,000 you pull out. In contrast, if you'd kept this money in a taxable account, you'd pay no more than $150 for every $1,000 withdrawal. Extending this a bit, an investor cashing out a $100,000 annuity would pay $35,000 in taxes vs. $15,000 in a taxable account.

“So it is likely that investors buying variable annuities will actually end up paying more in taxes and having less after-tax wealth at retirement. In fact, the tax deferral feature of annuities actually harms investors who hold mostly equities in their accounts. If these investors are not told that they are being tax-disadvantaged by this tax deferral feature, then their brokers are making material misrepresentations and omissions.” 401-K accounts also have the same tax problem.

“Further, the tax disadvantage won't die when you do. It can hurt your heirs. That's because your beneficiaries will be saddled with paying capital-gains tax on any profit your annuity generated. If your original $50,000 annuity grew to $75,000, your heirs would owe tax on the $25,000 profit. In contrast, if you had placed your money in taxable mutual funds, because of the step-up in basis, your kids would get that $25,000 tax free.”

Earlier I mentioned that many of my fellow teachers have fallen for annuity plans. Teachers do not have access to 401-K plans for retirement. The only similar thing that is available to them is the 403-B. This is one of the worst investment and retirement options ever conceived. Howard Clark, a scam blogger and radio talk host, states “In the worst cases, teacher’s unions are handling the retirement plans and are taking kickbacks for putting teachers in a certain annuity. In New York, for example, the New York State United Teachers union gets a $3 million kickback to put teachers in these plans. If you’re a teacher, you need to know about this and take action. You can transfer your money tax free to two low-cost companies. The companies with the lowest costs are TIAA-Cref and Vanguard. Both are much better choices than any kind of annuity your union is pushing on you.”

So how do you know the best way to invest your money? You hire an investment counselor or you respond to one of the many ads for investment services. You might as well give your money to me right now. I’ll spend it on a few cups of coffee that we can share and you’ll have gotten a better return.

Cox Broadcasting recently had a show about investment counseling. Their conclusion was, “One of the greatest danger points is in mid-career, when you find yourself with a great deal of money in a 401K. At that time you're at the greatest risk, because that's when you're most likely to end up hiring a commissioned salesperson. Is that a problem in itself? No. There are plenty of situations when paying a commission is just fine. But in the investment world, there can be inherent conflict of interest with commissions. There are plenty of investment products that may not be the best choice for you, but you may be sold on them by the person you hire simply because the commissions are humongous. Variable and Index Annuities are referred to as 'sold', not 'bought', since people don't buy these on their own -- they are convinced to do so. Salespeople use code words such as Retirement Secured Account and other phony phrases to keep from tipping you off that you're being sold an annuity. Sometimes a Life, or Immediate Annuity makes sense, but the commissions are so low you won't hear much about them.”

“You also need to stay away from "fee-based planners." These salespeople start with a fixed fee, but the commissions on products they may sell you defray those initial costs, which again, may not be in your best interest.”

Financial scams are not limited to annuities and the sale of high-commission investments. In fact, there are so many of them that it would be impossible to list all even in a 1,000-page book.

Credit cards use bait and switch. They offer you initially low rates that zoom upward quite rapidly. Debit cards have hidden fees and, with interest charged from the moment of use, they are among the worst ways you can shop.

Mortgages come in so many flavors that it’s often hard to know if you have been switched from the one you wanted. In 2007, a Seattle mortgage company used a unique scam. According to the Seattle Post-Intelligencer:

“While Linden Loans LLC advertised residential home loans at "1 percent, with no points and no fees," the state Department of Financial Institutions said it found that "not one borrower actually received those terms in 2006." The department is looking into the company's 2007 practices.”

"The 1 percent rate touted by Linden lasts only a matter of months, and requires borrowers to accept predatory loan terms that would greatly increase costs to borrowers," Deb Bortner, the department's director of consumer services, said in a statement. "Consumers have to be careful. Low rate, low-cost mortgage loans may be available, but they often result in borrowers paying more than they should."

The Los Angeles Times offers this hoax from 2008: “Federal authorities in Brooklyn today indicted two former Credit Suisse brokers, alleging that they tricked large corporations into buying more than $1 billion of so-called auction-rate securities tied to mortgage debt in recent years. The companies had hired Credit Suisse to invest their short-term cash reserves in auction-rate debt backed by federally insured student loans, according to the indictment. But the brokers instead often placed clients in auction-rate issues backed by subprime home loans and other mortgage-related debt known as collateralized debt obligations -- because those issues paid them "significantly higher" commissions, the government says.”

BusinessNet has this example: “According to an Oct. 29, 2002 securities fraud action filed by the SEC in U.S. District Court in Oklahoma, Southmark has defrauded at least 400 investors, most of them elderly, since 1996 with a "bait and switch" gimmick using advertisements for high-yielding certificates of deposit. Customers seeking the safety of CDs would inquire, the suit says, then Southmark agents would aggressively pitch to them "a purportedly personalized managed mutual fund investment program." The agents described the program as "as safe or safer" than CDs. But principal invested in mutual funds may depreciate, unlike CDs which guarantee a set return.”

“Also investors were sold Class "B" mutual fund shares that carry deferred sales charges (loads) and higher internal expenses than Class "A" shares. One customer, a retired commercial airline pilot, invested his $2.1 million retirement savings with Southmark and quickly incurred more than $84,000 in commission charges and fees, according to court records.”

Just because the institution has a known name, and a good reputation, does not mean that individual salesmen will not attempt to defraud their customers. Enter every financial transaction with your eyes opened.