Variable annuities could spell double trouble for brokers who eye fat commissions but ignore the rules in place for protecting investors.

Brokers can earn 7 percent or more in commissions on these insurance products, but when they sell them to consumers who aren't a good fit for them, they can face the wrath of regulators as well as investors who try to reclaim their money by filing securities arbitration cases.

At the Financial Industry Regulatory Authority, Wall Street's industry-funded watchdog, variable annuities follow stocks and mutual funds as the third most common source of complaints. They include one from an elderly investor who will be 102 before he can access the money he locked into his annuity.

Problems occur when brokers sell variable annuities without considering the client's time horizon for needing those funds, said Susan Axelrod, Finra’s head of regulatory operations.

So-called "annuity switching" is another concern. That happens when a broker encourages a client to trade in an older annuity to buy a different one, often at significant cost to the client and benefit to the broker. Some brokers also don't disclose fees for cashing in, or surrendering the annuity, Axelrod said.

Rich Rewards, Complex Contracts

An annuity is a type of insurance product that offers investors steady income payments, typically in exchange for a lump-sum investment. Payments can grow if financial markets do well because they are tied to an investment portfolio, usually consisting of mutual funds holding stocks and bonds.

Investors defer taxes on the income and gains until they withdraw their money, and typically the withdrawal period is deferred for several years while the value of the annuity builds up. Variable annuities are often sold to high-earning investors who already are making maximum contributions to their workplace retirement plans and want to invest more under similar tax structures.

Variable annuity sales in the U.S. totaled $142.8 billion last year, down a tad from $145 billion in 2012, according to the Insured Retirement Institute and Morningstar Inc.

Brokers are well rewarded for selling variable annuities, in part because of their high commissions and in part because those commissions don't typically fall as invested amounts rise, the way they do when money is put into mutual funds, for example.

Proponents argue that for their money, investors get those valuable tax breaks as well as a death benefit.

But their clients may not realize that they are tying up their money for as long as ten years. Clients may also not understand that hefty surrender charges apply if they cash in the product earlier, sometimes as much as 8 percent.

Even brokers who make a good-faith effort to explain the product can still fall short, risking angry clients who may complain to supervisors and regulators. "If the customer doesn't understand the product, the broker shouldn't sell it," said Joel Beck, a lawyer in Lawrenceville, Ga. who advises brokers.

One reason why clients may not grasp how a variable annuity works, Beck noted, is that the brokers who sold them may not have understood the product well enough to adequately explain them. "The more complex these products get, the more homework the broker has to do in terms of reviewing the product, the contract and marketing materials," Beck said.

Brokerages must have procedures and systems in place so that brokers can properly evaluate the costs and benefits of annuity exchanges, Finra’s Axelrod said. At large brokerages, variable annuity sales are typically subject to multiple screenings by computer software and a centralized review team, one brokerage executive said.

Facing Regulators

Disciplinary cases involving variable annuities are not as common in recent years as those stemming from other products, such as privately issued securities, but that does not mean that regulators are not looking.

Finra barred a broker last month who coaxed a customer to cash in one variable annuity and buy another. He told her that a $15,000 surrender charge did not apply to the transaction when, in fact, it did, according to a regulatory filing.

Florida insurance regulators have been examining what happens when brokers convince clients to exchange older annuities (which may have paid up front-loaded commissions) for new ones with new commissions.

In one Florida case, a broker advised a client to cash in a variable annuity and buy another that promised higher returns. But he bungled the tax treatment, leading to an unexpected $24,000 tax bill.

Brokers must do fact-finding about customers to determine if a variable annuity is suitable, based on factors such as their risk tolerance and age, said Lee Kell, who heads the bureau of enforcement for the division of securities at Florida's Office of Financial Regulation. That means becoming familiar with the intricacies of annuity contracts and fees, Kell said.

Cashing In At 102

Brokers who do not face off with regulators may have to deal with investors' lawyers in Finra's arbitration forum. Investors filed 174 arbitration cases involving variable annuities in 2013, according to Finra.

The cases typically name brokerage firms, but individual brokers usually must testify about the annuity sale and details about the complaint appear on the brokers' public record.

One recent case involves a 90-year-old investor who met his adviser at a free-lunch seminar, according to Scott Silver, his lawyer in Coral Springs, Fla. The investor ended up with an annuity that charges higher administrative fees than his previous one, said Silver. The extra fees will grind down the investors' returns over time, Silver said.

What's more, the new annuity has a 12-year holding period. "He must wait until he's 102 for access to his money," Silver said. "That certainly wasn't his objective."