Annuity surrender charges are fees the insurer takes if you pull out more than a set amount during the first several years of a contract. That window, called the surrender period, commonly runs about 6 to 10 years.
Surrender charges are the main reason an annuity is a long-term commitment. This lesson shows how a typical schedule works, how much you can usually take out free, and what to watch for with premium bonuses.
How do annuity surrender charges work?
Every deferred annuity has three phases. Two of them overlap, and that overlap is where buyers get caught.
- The accumulation period. Your money grows from credited interest or market returns, minus any fees. It can last a few years or several decades.
- The payout period. The annuity pays you as a lump sum, scheduled withdrawals or lifetime income. Many owners take partial withdrawals instead of ever reaching this phase formally.
- The surrender period. The first several years of the contract, running at the same time as accumulation. Withdrawals above a small free amount trigger a charge.
Why charge at all? The fee helps the insurer recover the sales commission and keep your money invested long enough to pay the promised rate.
The charge usually starts high and steps down each year until it reaches zero. According to the SEC’s guide to variable annuities, a typical schedule starts around 7% in year one and drops about a point a year. Some start higher, as high as 9%.
Here is what a hypothetical seven-year schedule might look like. Your contract lists its own exact numbers, and they are locked in when you buy.
| Contract year | Surrender charge |
|---|---|
| Year 1 | 7% |
| Year 2 | 6% |
| Year 3 | 5% |
| Year 4 | 4% |
| Year 5 | 3% |
| Year 6 | 2% |
| Year 7 | 1% |
| Year 8 and later | None |
A surrender charge is separate from taxes. Taking money out can also mean income tax on your gains, plus an extra 10% IRS tax if you are under age 59½.
How much can you withdraw without a surrender charge?
Many contracts let you take up to 10% of your account value each year with no surrender charge. Anything above that during the surrender period is charged.
Say you put $100,000 into the contract above, and in year two you need $30,000. Here is how the math would usually work.
- Free amount. 10% of $100,000, or $10,000, comes out with no charge.
- Charged amount. The other $20,000 is above the free limit.
- The charge. 6% of $20,000 is $1,200, taken from your money.
Contracts differ in the details, so read yours closely. Some base the free amount on your premium instead of your account value, and some add a market value adjustment that can raise or lower what you receive. Our guide to annuity withdrawal rules covers the variations.
Ask too whether the free amount is available in the first contract year. Also ask whether an unused free withdrawal carries over to the next year, since contracts handle both differently.
Is a premium bonus worth the lock-up?
Some annuities add a premium bonus, a lump sum the insurer puts into your account when you buy. It sounds like free money, but it almost always comes with strings.
- Vesting. The bonus often vests over several years, commonly about 7 to 10.
- Recapture. If you surrender early, the insurer takes back the part of the bonus that has not vested yet.
- Purpose. Insurers offer bonuses to keep your money in the contract longer.
A bonus only helps if you were going to stay the full term anyway. Ask what the contract gives up to pay for it, and compare the net result to a contract without a bonus.
What happens when the surrender period ends?
Once the schedule reaches zero, you can move your money without a surrender charge. Taxes still apply to any gains you take out.
- Take the money. Withdraw some or all of it.
- Stay put. Leave it in the contract at whatever rate the insurer now offers.
- Move it. Use a 1035 exchange to transfer the money to another annuity without triggering tax.
Watch the renewal terms closely. Some contracts start a new surrender period when you renew or accept a new rate.
- How many years is the surrender period, and what is the charge in each year?
- How much can I take out each year without a charge, and is it based on my account value or my premium?
- Does a market value adjustment apply to early withdrawals?
- If there is a premium bonus, how long until it fully vests, and what does the contract give up to pay for it?
- Are surrender charges waived for a nursing home stay or a terminal illness?
- When the surrender period ends, does renewing start a new one?
Check your understanding
Answer five quick questions to test what you learned about surrender charges.
Lesson 2 quiz: Surrender charges and free withdrawals
5 questions. No sign-up, nothing saved to our servers.
Common questions
Can you avoid annuity surrender charges?
Yes, in three main ways. Stay within the free withdrawal amount, wait until the surrender period ends, or cancel during the free look period right after you buy.
Is the surrender charge taken from your whole balance?
Usually not. In most contracts it applies only to the amount you take above the free withdrawal limit, and your contract spells out the exact math.
Do surrender charges ever go away?
Yes. The charge steps down each year and reaches zero when the surrender period ends, after which you can move your money without one.
The best defense is simple: pick a surrender period that ends before you might need the money. Next, lesson 3 looks at what stands behind the guarantee you are locking into, but first make sure you can read the schedule of annuity surrender charges in your own contract.