There can be a number of advantages to owning an annuity, including the tax-deferred growth of the funds within the contract, as well as the potential for an ongoing income stream in retirement, with guarantees that are backed by the financial strength and claims-paying ability of the issuing insurer.
While most annuities will allow you to withdraw some of your deposited funds – in many cases, up to 10 percent of the contract value each year – these financial vehicles may oftentimes also come with surrender charges if you withdraw more than the allowed amount.
What are Surrender Charges and How Do They Work?
Surrender charges are defined as being a “penalty for making an early withdrawal that is above the penalty-free withdrawal amount.” Generally, the surrender charge on an annuity will be determined as a percentage of the amount of money that is withdrawn. This percentage, and in turn the amount of the surrender charges, will typically decrease over time, often over a seven to ten year period of time, until the surrender charges are no longer applicable.
So, for example, an annuity may start out with a surrender period of eight years, and an initial surrender charge of 8 percent in the first year. Then, the percentage would gradually become less, until it eventually reaches 0 percent in the ninth year. In this case, the surrender charge schedule may look like the following:
|
Year 1 |
Year 2 |
Year 3 |
Year 4 |
Year 5 |
Year 6 |
Year 7 |
Year 8 |
Year 9+ |
|
8% |
7% |
6% |
5% |
4% |
3% |
2% |
1% |
0% |
In addition to the surrender charge on the initial amount of your annuity purchase, it is also possible that if you make any additional premium payments, there may be a separate surrender period for each of these.
As a hypothetical example, if your initial premium payment for an annuity was $10,000, and then you deposited another $5,000 two years later, the initial surrender period would be in place for your first deposit, and then a new surrender period would begin on the subsequent $5,000. Therefore, the surrender period for your $5,000 would still be in place for two years after the surrender period on your initial $10,000 expires.
Using the surrender period percentages above, if you were to withdraw a total of $12,000 four years after your initial deposit, you would incur a surrender charge of 5 percent on the first $10,000 and a charge of 7% on the additional $2,000 of your withdrawal. In this example, the total amount of surrender charge would equal $640.
$10,000 X 5%= $500
+
$2,000 X 7% = $140
These figures are shown for illustrative purposes only and are not guaranteed. They do not reflect taxes, product fees or expenses, which may reduce the figures shown here.
How Much Can You Be Charged If You Withdraw from an Annuity?
It is important to understand that, if you have the need to withdraw funds from an annuity, you will be taxed on the interest earned on the money, which is considered to be gain, and if you are under the age of 59 ½, you can also be charged an additional 10 percent “early withdrawal” penalty by the IRS (Internal Revenue Service). These amounts would be in addition to the surrender changes that are incurred.
With that in mind, it is recommended that the money you use to purchase an annuity not be the same funds that you may need to use in case of a financial emergency, and to consider the purchase of annuity to be a long term endeavor designed to supplement retirement income.
The Bottom Line on Annuity Surrender Charges
Most any financial vehicle will come with potential advantages and drawbacks – with one of these possible drawbacks being various sales and / or surrender charges. Yet, although you may be subject to a surrender charge schedule if you purchase an annuity, you can help yourself to avoid these fees by only using money that is earmarked for long term needs.
As with any other type of financial product, not all annuities are structured exactly alike. Therefore, it can be beneficial to work with a financial professional who is experienced in annuities in order to determine which one may be appropriate to help meet your specific needs.
By contacting Stratton & Company, you may be offered information regarding the purchase of insurance products. Any information on investments is meant to be general, as we cannot provide specific guidance regarding your investments or securities holdings. For such guidance, please consult with your own broker/dealer or Registered Investment Advisor. Our financial professionals do not offer estate planning, tax or legal advice. Always consult with a qualified advisor concerning your own situation.