Annuity Surrender Charges
An annuity is a written agreement between you and an annuity insurance provider. The core purpose of this contract is to serve as an investment account with opportunities to grow your money on a tax-deferred basis.
Just like any other insurance policy, an annuity also comes with certain beneficial features, such as turning your retirement savings account into a consistent income stream via periodic payments. You can purchase an annuity by paying a one-off lump-sum payment or making regular payments over a certain period of time.
The value of your annuity contract will depend on various factors, such as the performance of your chosen investment options. You can choose to invest in options such as money market instruments, bonds, stocks, and/or any combination of all three.
However, one thing is consistent with any type of annuity contract, i.e., annuity surrender charges. So, let us dive right in and discover what these annuity surrender charges are.
What Are Annuity Surrender Charges?
An annuity surrender charge refers to a type of sales charge. You have to pay a surrender charge in case you decide to sell or withdraw any sum of money from a variable annuity during a surrender period. A surrender period is a set time period typically lasting from six to eight years from the date of your annuity purchase.
This means, if you withdraw during this time, you will have to pay an annuity surrender charge. Doing so will also result in the reduction of your savings value and impact your returns of investment.
That said, you can ask your annuity insurance company to surrender the annuity at any point. The fee for the annuity surrender charge may vary by the time frame. For example, it may cost you up to 7 percent of your total investment amount if you surrender the annuity within the first year of purchase.
This percentage decreases with every passing year until your surrender period is over. After that, you can withdraw the amount as per the pre-determined payment cycle. That said, apart from the annuity surrender charges, you will also have to pay income tax on all your earnings through annuity investment options. Before you turn 59 ½, you will have to pay 10 percent early withdrawal charges.
Why Should I Pay Surrender Charges
You may wonder why annuity surrender charges are only for a certain number of years. It is only to allow your annuity provider to recoup the costs of offering you financial benefits for many years to come.
If you cash in or sell the annuity before the surrender period is over, you will be breaking a clause of the annuity contract; hence a surrender charge will apply.
This will protect your annuity insurance provider from losing a large sum of annuity funds before your contract matures. After all, they have invested a certain amount of money in investment on your behalf.
Annuity surrender charges provision allows the companies to offer and price their annuity products with rules and boundaries. This way, the plan stays beneficial for both the purchaser and the insurance company.
As you finish your surrender charge period, this is known as the surrender charge schedule. Once you enter the post surrender charges timeframe, you will have 100 percent access to your retirement plan funds without having to pay any annuity penalty.
How Does It Work?
An annuity insurance company assesses your annuity penalty charges when you withdraw any amount of money from your investment before the surrender time period. The company will automatically deduct the annuity surrender charges amount, and you will only receive the remainder of the amount.
While the surrender period varies from six to eight years, some insurance companies may decide to waive the surrender charges. Typically this only happens when your interest rate on the annuity contract is lower than a certain level of money.
There are three reasons why insurance companies charge surrender penalties which are:
- Companies cover their administration, sales, and operational costs by charging you a regular fee. If you decide to withdraw early, the companies will lose this fee; hence annuity surrender charges allow them to offset the operational cost.
- Annuity surrender charges are especially for those with long-term financial goals like retirement plans. Therefore, surrender charges help the companies deter short-term use of the policy. If you are looking for a savings account to dip into in case of emergencies, an annuity is not the solution.
- The annuity insurance company would require a time frame to invest your saving amount into investment options for maximum return on investment. The long-term investment will guarantee to yield exponential returns for the company as well as for you.
Are There Any Exceptions?
Yes, there are certain exceptions to annuity surrender charges. So while you will have to pay the penalty in case of early cash in or withdrawal, there are specific scenarios where you might not have to pay these charges.
For example, while most of the annuity agreements come with a free withdrawal provision in case of emergency withdrawal of a smaller amount. This means, if you withdraw a certain small percentage amount of your overall annuity contract value, you will not incur a surrender charge.
Moreover, the issuing company may also waive your annuity surrender charges in certain conditions. First, if you are a survivor collecting death benefits as a beneficiary for an annuity contract. Second, if you are a retiree who takes a required minimum distribution.
In order for you to know which exceptions does your insurance company offer, read the terms and conditions of your annuity contract thoroughly. These usually explain the specific circumstances and associated protocols to be eligible for an annuity surrender charge waiver.
In case you are in dire need of withdrawing cash from your annuity insurance policy, double-check the expiration dates of your surrender charges. If the time frame is about to expire, it is best to arrange the money from somewhere else and avoid paying surrender charges.
How Much Can Surrender Charges Be?
Annuity surrender charges may vary dramatically between each insurance provider and the products they offer. That said, the annuity surrender charges can reach the highs of 20 percent; however, it is not very often that you come across such atrocious penalty charges.
Typically, you can expect to pay an annuity surrender charge of roughly up to 10 percent within the first year of purchasing your annuity retirement plan. This percentile of penalty fee reduces as years go by.
How Much Can Annuity Surrender Charges Cost Me
While these charges vary by each company and policy you purchase, the typically annuity surrender charge starts at a certain percentage. With each passing year, this percentage decreases by 1 percent till it’s elimination entirely.
For example, your annuity company may charge you an 8 percent surrender fee in case of early withdrawal of funds in the first year. Now, if your surrender period lasts for eight years, the annuity surrender charge will decrease by 1 percent every year.
That means you will pay a 7 percent surrender fee in the second year, 6 percent in the third till it will fall to only 1 percent in the eight-year and zero after that.
Moreover, the shorter your surrender period, the higher the surrender charges you will have to pay. In some cases, the state may regulate the cost of your annuity surrender charges.
For example, the state of Idaho prohibits insurance companies from applying a surrender period lasting more than ten years. Moreover, the companies cannot charge more than 10 percent of the annuity surrender charge in the first year of purchase.
Is Investment with Annuity Surrender Charges Worth It?
First thing first, you must always remember a general rule of thumb, i.e., annuity surrender charges will reduce the overall value of your investment in case of withdrawal. That said, high-quality annuity contracts, mutual funds, and life insurance policies with annuity surrender charges may still be a valuable and worthwhile retirement-saving plan.
Are you looking for a long-term investment plan with no problems with long-term withdrawal restrictions? In that case, annuities are among the best and most promising options for high returns on investments.
However, if you are looking for a short-term investment domain and need high liquidity, an annuity is not an ideal product as it will impose surrender charges. In case you are not sure if you fall in the long-term or short-term investment categories, it is best to seek professional assistance from a financial advisor.
These financial planners are mostly independent and do not get any commission for promoting annuity products. This will guarantee that a planner will only recommend an annuity contract suitable for your financial circumstances and goals.
When you decide to choose an annuity product that is asking for a surrender charge, you must check the benefits it is offering. These include long-term capital amount appreciation, the potential for regular income after retirement. These may offer services that compensate for the lack of access to your cash.
How to Avoid Annuity Surrender Charges
Certain aspects can help you reduce or avoid the annuity surrender charges entirely. One of the obvious ones is to sit out the entire surrender period. While this is often not a feasible option, you can still earn a waiver or reduce the annuity surrender penalty.
You can continue to hold your annuity policy in such circumstances until it matures and you continue to receive consistent periodic income payments.
Another good way is to shop for an annuity product that will offer you lower or flexible exemptions from paying early withdrawal surrender charges. You may even be able to purchase an annuity that will not charge any fee whatsoever. However, they may charge you higher annual expenses instead in order to manage your annuity.
Most people either ignore or are completely unaware of the surrender charges clause in their annuity insurance plans. However, you must ask your insurance company to give you full information on the matter to avoid disappointment and future financial shocks if you need to withdraw early.
Annuities are expensive financial products, and their management expenses are somewhat similar to other investment options. Always remember that the underlying insurance features of an annuity plan require a thorough underwriting process.
So you must add in the expenses of your broker’s commission. You must also consider the years it will take for the insurance company to turn your investment into profit on the annuity you purchased. While the company may levy stiff surrender penalties in case you wish to recover your capital early, there are several ways you can minimize or avoid these penalties.
5 Ways to Avoid Surrender Charges
Here are five main ways that can help you avoid annuity surrender charges. However, not all of them may apply to your annuity plan:
- You must wait your surrender period out. This is the long route, and if you do not require a significant amount, you can ask a friend or family to help you out and return that money later. This is better because you will avoid surrender charges and save money on paying additional income tax when withdrawing the amount.
- You can withdraw your capital funds incrementally as the years pass by. Most annuity plans allow you to withdraw 10 percent to 15 percent of your overall balance each year. This facility comes without any penalty; however, you will still have to bear the income tax applicable at the time of withdrawal.
- You can purchase a “level-load” or “no-surrender” annuity insurance policy. These annuities charge a higher annual fee than traditional annuities. This way, you will not be paying a surrender fee, and in case you want to pull out, the trade-off will be worthwhile.
- You can re-allocate your investments, especially if your annuity is not performing well. It is best to change your underlying investment instead of surrendering the entire annuity plan. Most annuity company providers charge a little to no fee at all for these types of internal financial transfers.
- Under the tax code section 1035, you can exchange one annuity plan for another. In case you switch your annuity plan offered by the same provider, there will be no surrender fee in most cases. This is also an efficient mode to avoid tax penalties, which you would have paid in case of withdrawals.
In Conclusion
In case you are considering purchasing annuity but do not know which ones offer the lowest or no annuity surrender charges, seek professional assistance from a financial advisor. This will also help you bag the best annuity plan to maximize your return on investment in your post-retirement days.