Surrender Charges Explained
Annuities have surrender charge periods generally lasting from 3 years to 16 years depending on the one you choose.
The surrender fees, which are imposed above the 10% penalty free amount annually, typically range from 5% to 20%.
The highest penalties are typically associated with annuities that offer a 10% bonus, which in effect may reduce your 20% penalty to 10%.
The surrender fees reduce over the years you own the annuity to zero allowing for 100% liquidity of your annuity after the surrender period expires.
Surrender periods are also waived upon the death of the annuitant allowing a spouse named as the primary beneficiary to take over the annuity without penalty and also allowing for ongoing withdrawals of any amount up to the full account balance without penalty.
Annuities are not 100% liquid during the surrender charge period. This allows the insurance company the confidence to invest your money for a longer term without the risk that you call them in the near term asking for a withdrawal above the 10% amount allowed without penalty. By investing longer this potentially allows for a higher yield to both the company and you. Annuities are not unlike Bank CD’s in that there is a penalty for early withdrawal except that annuities do typically allow 10% to be withdrawn annually.
Because annuities allow for tax deferral on the funds you have invested the IRS will impose a 10% penalty for funds withdrawn prior to reaching your 59-1/2 birthday. This is true of any tax deferred vehicle such as IRA’s 401k’s, 403b’s etc…
Is 10% enough liquidity annually? Using the example of $100,000 placed in an annuity offering a 10% penalty free withdrawal, which many do, you could take out $10,000 annually or the entire original balance in ten years.
Most people would find that spending their savings at the rate of 10% annually would deplete them of their savings well in advance of life expectancies.
Annuity surrender charges are not imposed upon you unless you take more than the penalty free amount. This means you control whether you will ever pay a penalty.
Surrender charges do not occur involuntarily like the markets volatility, which may impact, savings negatively such as has occurred twice from 2000 to 2009.
The purpose of money should dictate where you place it. Fixed Annuities are best suited for nest egg dollars that need to be kept safe and provide you an income for as long as you live.
Annuities have the unique ability to continue to pay you lifetime income even after the depletion of your principal. So even if you run out of money with an annuity you would not run out of income.
Annuities and Social Security are the only vehicles that offer lifetime incomes. The annuity gets its strength from the claims paying ability of the insurance company and Social Security from the Federal Governments collection and management of taxes.