When considering an annuity, it’s crucial to understand surrender charges and how they can impact your ability to access your funds. While annuities offer several benefits, including guaranteed income, their associated fees, such as surrender charges, can be a significant factor in your decision-making process. Here’s what you need to know.

What Are Surrender Charges?

Surrender charges are fees applied when you withdraw funds from an annuity within a specified period, known as the “surrender charge period.” This period typically begins when you sign the annuity contract. For some annuities, there may be a “rolling” surrender charge period, meaning each additional payment into the annuity has its own individual surrender period.

The fees are designed to discourage early withdrawals, ensuring that the annuity company can invest your funds for the long term. These charges typically decrease over time and eventually disappear once the surrender period ends. For example:

• Year 1: 6%
• Year 2: 5%
• Year 3: 4%
• Year 4: 3%
• Year 5: 2%
• Year 6: 1%
• Year 7: No charge

In this scenario, if you withdrew $10,000 in the second year, the surrender charge would be 5%, or $500. The specific charge schedule varies depending on the annuity type and contract terms.

Free Withdrawal Provision

Most annuities come with a “free withdrawal” provision, allowing you to withdraw a portion of your funds without incurring surrender charges. Typically, you can withdraw up to 10% of your account balance each year penalty-free. However, any withdrawals above this amount may be subject to the surrender charge, along with ordinary income tax. Additionally, if you withdraw funds before age 59½, you may face a 10% early withdrawal penalty from the IRS.

Circumstances Where Surrender Charges Are Waived

In some situations, surrender charges may be waived. For example, withdrawals for a required minimum distribution (RMD) or death benefits may be exempt from surrender charges. Additionally, certain annuitization options could result in waived surrender charges.

Why Do Annuities Have Surrender Charges?

Surrender charges serve several purposes. Primarily, they encourage long-term investment, which aligns with the purpose of annuities — to provide income over time, especially for retirement. These charges also help insurance companies recoup their costs for administering and selling the annuity. Annuity contracts involve significant operational and legal expenses, and the surrender charge helps offset these costs if you withdraw early.

Understanding Market Value Adjustments (MVAs)

In addition to surrender charges, some annuities may have what is known as a Market Value Adjustment (MVA). This adjustment is generally applied to fixed annuities and can either increase or decrease the amount you can withdraw, depending on the prevailing interest rates. If interest rates have risen since you purchased the annuity, your withdrawal may be reduced; if rates have dropped, it could be increased. MVAs vary depending on the type of annuity and market conditions, so it’s essential to understand if this applies to the annuity you’re considering.

Questions to Ask About Surrender Charges

Before purchasing an annuity, ask yourself the following questions to determine if the surrender charges are manageable:

• Will I need access to the funds before the surrender period ends?
• Do I have other liquid assets to use in case of an emergency?
• Does the annuity allow for free annual withdrawals?

The answers to these questions depend largely on your specific financial goals and the type of annuity you’re interested in. Annuities can serve various purposes, from providing retirement income to hedging against longevity risks. Understanding the terms and conditions, including surrender charges, will help you make an informed decision.

Conclusion

Annuities can be a valuable part of a retirement strategy, offering financial security and guaranteed income. However, it’s essential to understand how surrender charges work and what their impact could be if you need to access your funds early. By carefully considering the terms of the annuity, your financial needs, and consulting with a financial advisor, you can make the right choice for your long-term financial goals.