What you need to know about annuity surrender charges

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Give up surrender charges, not your savings.

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A deferred annuity offers a way to save for the future while building cash value over time. Premiums paid into the annuity grow to provide a predictable income stream during retirement, offering financial security for those looking to lock in stable payments later in life.

But accessing your funds early can come at a cost. If you need to withdraw money before regular payments begin, surrender charges—fees imposed for early withdrawals—can significantly reduce how much you receive. Understanding these charges is essential to deciding whether an annuity fits your financial goals.

An annuity is a life insurance contract, similar to permanent life insurance, that builds cash value over time. Many annuity contracts include a death benefit that provides regular payments once you build enough cash value. Although most consumers typically don’t purchase an annuity or life insurance policy with the intent of withdrawing money early, life’s uncertainties may require you to use those funds. When you cancel your annuity or permanent life insurance contract before it matures, the amount you receive is called the surrender value.

The surrender value typically includes your annuity’s accumulated cash value, calculated as the payments you’ve made plus any interest or investment gains, minus surrender charges, administrative fees, prior withdrawals, and outstanding loans.

Beyond withdrawals and loans, surrender charges can significantly reduce the amount you receive.

Sometimes called a withdrawal fee, a surrender charge represents the penalty charged when you take money from a deferred annuity. Surrender charges apply to deferred annuities (since immediate annuities are purchased to provide income instantly).

Annuity surrender charges fall into two categories:

Depending on your situation, you might be better off withdrawing from your annuity’s value than canceling your contract.

Understanding the surrender charge schedule is crucial when buying a deferred annuity. These charges are designed to discourage you from using annuities as short-term investments and to help the issuing company recover its costs, including commissions and administrative fees.

A typical surrender charge schedule lasts 6 to 10 years, with the fee decreasing each year. For example, the charge might start at 8% in the first year and drop by one percentage point annually, reaching zero once the surrender period ends.

Some annuities also allow penalty-free withdrawals during the surrender period. This provision often lets you withdraw up to 10% of your contract’s value each year without charge. Exceeding that threshold—or fully cashing out your contract—can result in significant fees.

Before purchasing an annuity, review the surrender charge and consider whether you might need to use your funds during the early years of the contract. The idea behind an annuity is to provide regular income later on. If you anticipate financial needs that could lead to early withdrawals, a financial product that offers better liquidity—that is, ease of access to cash—might be a better fit. Examples include certificates of deposit (CDs) or money market funds.

Suppose you spend $250,000 to purchase a deferred variable annuity with an eight-year surrender period. The surrender charge starts at 8% in the first year and decreases by one percentage point each year, reaching 6% in year three.

In the third year, you withdraw $75,000 to cover unexpected expenses. Your contract allows you to withdraw up to 10% of the annuity’s value penalty free, which amounts to $25,000. The remaining $50,000 is subject to the 6% surrender charge, resulting in a fee of $3,000.

You receive $72,000 from your $75,000 withdrawal after subtracting the surrender charge.

If you’re concerned about market fluctuations during retirement, an annuity provides stable, regular payments and, when combined with Social Security income, can help to ensure living expenses are met. Income from other sources, such as your stock portfolio, can supplement your lifestyle.

It’s important to choose an annuity that best suits your situation. Not all annuities include a death benefit, which may be crucial if you want to leave a financial legacy to your beneficiaries. If so, a permanent life insurance policy that builds cash value might make more sense. Alternatively, you can choose an annuity with a death benefit and pay a higher premium.

Some decide to build an investment portfolio and not worry about using an annuity for expenses later. Carefully read the contract terms and consider your needs before committing to an annuity contract.

Annuities can provide peace of mind by reducing financial uncertainty in retirement. Although annuities are designed for long-term income, life’s expenses can be unpredictable, and you may find you suddenly need the money you intended to sit tight in an annuity. Because annuities are designed for long-term income, accessing these funds early often incurs substantial surrender charges, reducing how much you can withdraw. To avoid unexpected costs, review the surrender charge schedule and ensure you have enough cash stashed away for emergencies before purchasing an annuity.