Annuity Surrender Charges and Fees, Explained

Short version. A surrender charge is a fee a carrier may deduct if you take more than the allowed amount out of an annuity, or cancel it, during the surrender period. That period commonly runs five to ten years, and the charge typically starts higher and steps down each year until it reaches zero. Most contracts also let you withdraw a set percentage each year with no charge, and some add a market value adjustment that can raise or lower what you receive. The fees worth knowing about are the surrender schedule, rider charges, and any fund expenses inside a variable contract.

How Annuity Surrender Charges Work

When you buy an annuity, the carrier invests your money for the long term and pays an agent or advisor from its own funds. The surrender charge is how the carrier protects itself if you leave early. It is written into the contract, and the schedule is printed in the contract itself, so you can read it before you sign.

A typical schedule might start in the high single digits in year one and drop by about a point each year. Your contract may look different. Some carriers use a flat charge for a few years, and some start lower. The only schedule that matters is the one in your paperwork.

Here is the part people miss. The charge usually applies to the amount you take out, not to your whole account. If you withdraw within the free amount, there is typically no charge at all.

The Annuity Surrender Period

The surrender period is the stretch of years the charge can apply. Shorter periods exist, and so do longer ones. According to FINRA's annuity guidance, variable annuities in particular can carry surrender periods of eight years or more.

A few things tend to be true across products:

• A longer surrender period often comes with a higher stated rate or bonus, because the carrier has more time to work with your money.
• The clock usually starts on the date you fund the contract. A new deposit can start its own clock.
• Once the period ends, you can generally take money out without a surrender charge, though income tax still applies to gains.

Free Withdrawal Provision on an Annuity

Most contracts include a free withdrawal provision. It lets you take out a set amount each year with no surrender charge. Ten percent of the account value is common, and some contracts base it on premium instead. Some start the allowance in year two, and some offer it from day one.

What Else Can Waive the Charge

Many contracts add waivers for certain life events, such as a terminal illness diagnosis or confinement in a nursing home. Death of the owner typically passes the value to beneficiaries without a surrender charge. These waivers vary widely, and some require a waiting period, so ask for the exact wording.

Required Minimum Distributions

If the annuity sits inside an IRA, required minimum distributions generally count toward the free amount. Ask the carrier how it treats them before you rely on that.

Market Value Adjustment, in Plain English

Some fixed annuities carry a market value adjustment, or MVA. It compares interest rates when you bought the contract with rates on the day you take money out early. If rates have risen, the adjustment may reduce your payout. If rates have fallen, it may increase it.

It is one more reason to ask whether a contract has one, whether it applies on top of the surrender charge, and whether it can work in your favor. Contracts differ. Some limit how far the adjustment can go in either direction.

Other Annuity Fees Beyond Surrender Charges

The surrender charge gets the attention, but it is not the only cost. Depending on the type of annuity, you may see:

• Rider charges. An income rider typically carries an annual fee, often a percentage of the benefit base or account value.
• Mortality and expense charges. These apply to variable annuities.
• Investment fund expenses. Variable annuities also pass through the expense ratios of the funds you choose.
• Administrative or contract fees. A flat annual fee is common on some variable contracts.

Fixed and fixed indexed annuities often have no annual fee unless you add a rider. That does not make them cheaper in every case. The cost may be built into the crediting terms, such as a cap or participation rate. Our look at fixed indexed annuity pros and cons covers how those terms work.

Surrender Charges and Taxes Are Two Different Things

People often mix these up. A surrender charge comes from the carrier and is set by the contract. The 10% federal tax penalty on withdrawals before age 59 and a half comes from the IRS and applies to the taxable gain. You can owe one, the other, both, or neither. Withdrawals of gain are generally taxed as ordinary income. Your CPA can tell you how it applies to your situation.

Is an Annuity With a Surrender Period a Bad Idea?

No. It is a trade. The carrier can offer guarantees such as principal protection or income you cannot outlive because it knows your money will stay put. The question is whether the money you are putting in can stay put.

Good candidates are usually people with emergency savings already set aside, other accounts to draw from, and a clear plan for the annuity money, such as a future income floor. A poor fit is money you may need within the surrender period. For liquidity, many families pair an annuity with a properly designed whole life policy, which we describe as The No-Compromise Asset: protection your family needs AND money you can use while living. Our retirement income strategy page shows how those pieces can work together, and our annuities overview compares the main contract types.

A surrender charge only costs you something if you leave early. The best protection is to know the schedule before you sign.

Questions to Ask Before You Sign

1. What is the surrender schedule, year by year?
2. How much can I withdraw each year with no charge, and does that start in year one?
3. Does the contract have an MVA, and can it help me as well as hurt me?
4. What waivers apply, and what are the exact conditions?
5. What are all the annual charges, including riders and fund expenses?
6. What does this carrier's financial strength rating look like?

If you already own a contract and want to understand the schedule, book a no-pressure conversation with us and we will read it with you. We would rather you know the terms now than be surprised later.