Annuities and Surrender Periods

Annuities can provide you with a wide range of benefits, including tax-deferred growth on your funds, and an income stream in the future that you cannot outlive - regardless of how long you may need it.

Along with these enticing features, though, there are also some items that you need to know about annuities. That is because, just like most other financial vehicles, there could also be some "trade-offs" that you need to make in order to receive the benefits. These trade-offs could include surrender charges.

How Annuity Surrender Charges Work

A surrender charge is defined as an amount that you must pay if you withdraw money from an annuity. In most cases, annuities will have surrender charges if funds are withdrawn within the first several years of purchase.

All annuities differ, but typically the "surrender period" will last anywhere from just a few years to more than ten years - and the amount of the surrender charge will usually grade down until it reaches 0%.

With most annuities, you are allowed to withdraw up to 10% of the contract value penalty-free starting the first year. However, while you are still in the annuity's surrender period, you could incur a surrender charge on any amount that is over and above 10%. Once the surrender period has elapsed, and you are no longer within the surrender period, the surrender penalty will no longer apply.

Surrender fees are typically a percentage of the withdrawal amount. An example of an annuity's surrender charge period and percentages may look like the following:

Contract Year 1 2 3 4 5 6 7 8 9+
Surrender Charge % 8 7 6 5 4 3 2 1 0

In addition to the surrender charge from the annuity itself, it is also important to be mindful of having to pay an "early withdrawal" penalty to the IRS (Internal Revenue Service). In this case, the IRS penalty could apply if you make a withdrawal and you are under the age of 59 1/2.

Although some people may shy away from annuities due to the surrender charges, the reality is that there are many other financial vehicles, such as bonds and CDs (certificates of deposit), that may "penalize" investors for withdrawing funds early.

With that in mind, one of the best strategies for taking advantage of all that an annuity has to offer, yet without the worry of incurring a surrender penalty, is to only contribute funds that you will not need for other purposes (such as emergencies or paying off debts).

Determining the Right Annuity for Your Needs

There are a number of different types of annuities available today, and the features can vary - sometimes quite significantly - from one to another. This means that what may be a benefit to some people could be considered a drawback to others.

But in any case, annuities should be considered as a long-term financial endeavor, and the money that you put into an annuity should not be earmarked for other needs, such as financial emergencies, as it could be costly for you to make a withdrawal in the early years.

Therefore, it is always recommended that you discuss your short- and long-term financial goals with a professional in the annuity area. From there, you will be better able to narrow down which annuity is right for you.