When you purchase an annuity, you may be subject to surrender charges. This is a fee that the insurance company charges to customers who terminate their contracts before a certain period of time have passed. Typically, surrender charges decrease over time, so it’s essential to weigh all your options before deciding. Here we’ll explore what surrender charges are and how they work.
What Does It Mean to Surrender an Annuity?
If you want to end your annuity contract early and receive the cash value, this is called a surrender. You will have to pay a fee for doing this.
What Are Surrender Charges?
Surrender charges for annuities are the penalty a contract owner will receive if they surrender (cancel) their deferred annuity contract before the agreed surrender charge period or withdraw a portion of their account balance above their allotted penalty-free withdrawal amount.
If you cancel your deferred annuity contract before the surrender period (total or partial surrender) expires, you will incur surrender fees, aka a surrender charge.
If the requested annuity withdrawal is more than what you’re allowed in a given year, you will incur a penalty for every dollar above that amount.
If you surrender your contract early, you will have the Cash Surrender Value. The CSV is the current Accumulation Value minus surrender charges taken out.
Complete surrender is canceling 100% of your contract, while a partial surrender is canceling only a portion of your contract (above your free withdrawal).
Surrender charges are standard in all deferred annuities, including the traditional, variable, two-tiered, and fixed indexed annuities.
Why are there surrender charges?
There are surrender charges to protect the insurance company from losing significant annuity funds at any given time. This is why there is a contract in place. In addition, surrender charge provisions help actuaries price their deferred annuity products efficiently by creating rules and boundaries.
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When do surrender charges stop?
When an owner completes your surrender charge period, also known as a surrender charge schedule or annuity period, your funds in the retirement plan are typically 100% liquid without an annuity penalty at that point.
How high do surrender charges go up?
Annuity surrender charges vary dramatically by insurance company and product.
With that said, I’ve seen a high starting surrender charge as high as 20%. Don’t let that scare you. That particular deferred annuity has been around for over a decade when surrender charges were very high.
You can expect a first year’s surrender charge to be roughly 10% and a decline in percentage each year.
Annuity Surrender Charge Example
You sign up for a deferred annuity with a 10-year surrender period for $100,000.
You decide you want to cancel your contract in year 5.
Your annuity is worth $150,000, and there’s a 7% penalty for year 5.
You’ll have a penalty of $10,500; in return, you’ll pocket $139,500.
You sign up for a deferred annuity with a 10-year surrender period for $100,000.
You can withdraw up to 10% of your account balance annually without penalty.
Your annuity is worth $150,000 in year 5, and you’re allowed to pocket up to $15,000 that year, penalty-free.
You withdrew $17,000 that year, $2,000 over the penalty-free limit.
There’s a 7% penalty for year 5.
You’ll incur a penalty of 7% of the excess $2,000, which is $140.
What is a Surrender Charge Schedule?
A surrender charge schedule is simply the schedule of your annuity contract term and the applicable surrender charges in the given year of your retirement plan.
10-Year Surrender Charge Schedule Example
- Year 1 = 10% penalty
- Year 2 = 9% penalty
- Year 3 = 8% penalty
- Year 4 = 7% penalty
- Year 5 =6% penalty
- Year 6 = 5% penalty
- Year 7 = 4% penalty
- Year 8 = 3% penalty
- Year 9 = 2% penalty
- Year 10 = 1% penalty
- Year 11 = 0% penalty
Surrender Charge Exemptions
Every annuity product varies, but the standard features for exemptions in the surrender clauses are:
The standard death benefit with deferred annuities is your account value passed onto the named beneficiaries in a lump-sum payment. In addition, all surrender fees from the insurance company are waived.
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Assistance with Activities of Daily Living:
Suppose the annuity contract owner can not meet 2 out of the six activities of daily living (bathing, grooming, dressing, toilet hygiene, mobility, and self-feeding). In that case, the insurance company will waive the surrender fees to provide additional financial assistance.
Home Health Care
Home Health Care sometimes ties into the ADLs above. Still, suppose an annuity contract owner needs home health care for a specific time. In that case, a Home Health Care waiver can kick in, and the insurance company will waive all surrender fees for additional financial assistance.
Nursing Home Care or Confinement
If the annuity contract owner has to enter a qualified facility for confinement, such as a Nursing Home, a waiver canceling all surrender penalties can kick in after a certain period in the facility has gone by.
Assisted Living Facility
Like the Nursing Home surrender clauses, if an annuity owner enters an Assisted Living Facility for a certain period of consecutive days, a waiver from the insurance company can apply and waive all the surrender fees.
If a physician determines you will leave for 12 months or less, a Terminal Illness waiver can apply and waive all surrender charges for additional financial assistance.
These types of waivers vary from one annuity product to the next, so please check your contract to find your options.
How To Avoid Surrender Charges
You can purchase an annuity with a shorter surrender period. Deferred annuity contracts start as short as a 3-year-contract.
You can purchase a deferred annuity with extra liquidity or a Return of Premium provision.
You can find a contract that offers a lower starting charge. We can help you with researching these contracts.
If you are already in an annuity contract, find your annual penalty-free withdrawal provision and withdraw that amount each year until you complete the contract.
Tip* Check to see if your contract has an MVA. Your cash surrender value might reflect a policy value worth liquidating. I’ve seen low-interest-rate environments where an owner can surrender the policy’s entire value without penalties due to the Market Value Adjustment (MVA). This is rare but always worth checking.
If you’re thinking of purchasing an annuity, it’s essential to understand the surrender charges that may apply. The good news is that surrender charges typically decrease over time, so you’ll have plenty of opportunities to decide. Contact us today for a free quote, and we can help you weigh your options.
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Frequently Asked Questions
When is an annuity surrendered early the annuitant receives?
The annuitant receives the cash surrender value when an annuity is surrendered early.
What is a surrender charge on an annuity?
A surrender charge is a fee if you cash in your annuity before maturity. The fee is typically a percentage of the total value of the annuity, and it is designed to discourage investors from cashing in their investments early. Surrender charges are generally highest during the first few years of an annuity contract, and they typically decline each year until they disappear entirely.
Do annuities have surrender charges?
Yes, most annuities have surrender charges. The fee is typically a percentage of the total value of the annuity, and it is designed to discourage investors from cashing in their investments early. Surrender charges are generally highest during the first few years of an annuity contract, and they typically decline each year until they disappear entirely.
How do you avoid surrender charges?
The best way to avoid surrender charges is to wait until the surrender charge period has expired. This is typically several years after you purchase the annuity. However, there may be other ways to avoid or minimize surrender charges, depending on the terms of your contract. For example, some contracts allow you to withdraw a certain percentage of your investment each year without incurring a surrender charge. Speak to your financial advisor to learn more about your options.
Can annuity surrender charges be waived?
In some cases, annuity surrender charges can be waived. For example, if you are terminally ill or permanently disabled, you may be able to cash in your annuity without paying a surrender charge. Speak to your financial advisor to learn more about your options.
What happens if I surrender my annuity?
If you surrender your annuity, you will receive a lump sum payment for the current value of your investment. Any outstanding charges will reduce this value, such as the surrender charge. Once you cash out, you will no longer receive any future payments from the annuity.
How do you calculate surrender charges?
Surrender charges are typically a percentage of the total value of the annuity. To calculate the charge, you multiply the total value of the annuity by the surrender charge percentage. For example, if you have an annuity with a current value of $10,000 and a surrender charge of 5%, the surrender charge would be $500.
What is the purpose of a surrender charge in a deferred annuity?
A deferred annuity’s surrender charge discourages investors from cashing in their investment early. The fee is typically a percentage of the total value of the annuity. It is designed to reduce the amount of money an investor would receive if they cashed in their investment before the maturity date. Surrender charges are generally highest during the first few years of an annuity contract, and they typically decline each year until they disappear entirely.
How long does it take to surrender an annuity?
The time it takes to surrender an annuity depends on the terms of your contract. For example, some annuities allow you to cash in your investment immediately, while others may require you to wait for a certain period before accessing your money.
What does out of surrender mean on an annuity?
Out of surrender means you are no longer subject to the surrender charge. This typically happens after the surrender charge period has expired. Once you are out of surrender, you can cash in your annuity without paying a fee.
What is the initial surrender charge?
The initial surrender charge is the fee you will pay if you cash in your annuity during the first few years of the contract. This fee is designed to discourage investors from cashing in their investments early. The initial surrender charge is typically a percentage of the total value of the annuity, and it declines each year until it disappears completely.
What is a free look period on an annuity?
A free look period is when you can cancel your annuity contract without paying a surrender charge. This period typically lasts 10-30 days after you purchase the annuity.
What is a surrender period?
A surrender period is the length of time you will be charged a fee if you cash in your annuity. This period is typically 5-10 years. After the surrender period has expired, you can cash in your annuity without paying a fee.
What are some alternatives to cashing out an annuity?
If you need access to your money before the maturity date, you may be able to take a loan from your annuity. This option lets you keep your investment intact and avoid paying a surrender charge. You will, however, have to pay interest on the loan, and you may be required to repay the loan with interest if you surrender your annuity before the maturity date. Another option is to withdraw a portion of your investment. This allows you to access some of your money while maintaining your investment and avoiding a surrender charge. You may, however, have to pay taxes on the withdrawal.
Is cashing out an annuity considered income?
When you cash out an annuity, you will typically have to pay ordinary taxes on the withdrawal. The amount of taxes you owe will depend on your tax bracket and the money you withdraw. You may also owe a 10% early withdrawal penalty if younger than 59 1/2.
Can I withdraw my annuity?
Yes, you can typically withdraw money from your annuity at any time. Depending on the type of annuity you have, you may be able to withdraw up to 10% annually without a penalty.
Is surrender charges tax deductible?
No, surrender charges are not tax deductible.
What is a surrender charge on an annuity?
A surrender charge on an annuity is a fee imposed by the insurance company if the annuity owner withdraws or surrenders the contract before a specified date, typically a number of years after the annuity is purchased. The purpose of the surrender charge is to discourage early withdrawals and to help recover some of the costs the insurance company incurs in issuing the annuity. Surrender charges can range from a few percent to as much as 20% of the contract value and typically decline over time.
What is the function of a surrender charge waiver in an annuity contract?
A surrender charge waiver in an annuity contract is a feature that allows the annuity owner to withdraw or surrender the contract without incurring a surrender charge. Typically, this feature is triggered by certain events, such as the annuity owner’s death, terminal illness, or confinement to a nursing home. The purpose of the surrender charge waiver is to provide the annuity owner with greater flexibility and to help ensure that they have access to their funds in the event of an unexpected need.
What happens if a deferred annuity is surrendered before the annuitization period?
If a deferred annuity is surrendered before the annuitization period, the annuity owner may receive a surrender value, which is the cash value of the contract less any applicable surrender charges. The surrender value can be used to purchase another annuity, invest in another product, or used it for other purposes.