Early withdrawal penalty in annuities
Quick Definition: A surrender charge is a penalty for withdrawing more than the allowed amount from your annuity during the surrender period (typically 5-10 years). Charges usually start at 7-10% and decline to 0% over time.
When you buy an annuity, the insurance company pays your advisor a commission upfront—typically 5-7% of your premium. They recoup this cost over time through fees and investment earnings.
If you withdraw your money early, they haven't had time to recover their costs. Surrender charges compensate the insurance company for this loss and discourage people from treating annuities like bank accounts.
Think of it like a gym membership with a long contract. If you quit early, there's a penalty. The insurance company made commitments (guaranteed rates, commissions paid) based on you keeping your money there for the agreed period.
Surrender charges decline over time on a set schedule. Here's what a typical 7-year schedule looks like:
| Year | Surrender Charge | On $100,000 Withdrawal |
|---|---|---|
| Year 1 | 8% | $8,000 penalty |
| Year 2 | 7% | $7,000 penalty |
| Year 3 | 6% | $6,000 penalty |
| Year 4 | 5% | $5,000 penalty |
| Year 5 | 4% | $4,000 penalty |
| Year 6 | 3% | $3,000 penalty |
| Year 7 | 2% | $2,000 penalty |
| Year 8+ | 0% | No penalty |
Variation by product type:
Scenario: Mike buys a $200,000 FIA with a 9% year-1 surrender charge declining to 0% over 9 years.
Year 3 emergency: Mike needs $75,000 for unexpected medical bills.
Free withdrawal: He can take 10% without penalty = $20,000
Remaining needed: $75,000 - $20,000 = $55,000
Surrender charge (Year 3): 7% × $55,000 = $3,850
Total withdrawal: $75,000 - $3,850 = $71,150 net
Mike lost $3,850 to the surrender charge—money he could have kept if he'd waited until year 10 or kept that money in a more liquid account.
Almost all annuities include a "free withdrawal" provision—typically 10% of your account value per year without surrender charges.
Important clarifications:
Most annuities waive surrender charges for specific hardships:
Requirements vary by carrier and must be documented with medical records or facility statements.
1. Wait out the surrender period
The most obvious solution. If you can wait, do.
2. Use the free withdrawal provision
Take your 10% annually if you need income. Plan withdrawals accordingly.
3. Buy shorter surrender periods
If you might need liquidity, choose 5-year products over 10-year products. Trade-off: usually lower rates or features.
4. 1035 Exchange strategically
If you're past year 7-8, consider exchanging to a better product. But beware: the new annuity will have a new surrender period.
5. Don't put money in annuities you might need
This should be money you can afford to lock up. Keep 6-12 months expenses liquid elsewhere.
⚠️ Critical Mistake: Some people buy annuities with money they might need soon (like for a house down payment in 3 years). This is a disaster. Surrender charges can cost you thousands. Only use money you're certain you won't need during the surrender period.
These are different and can stack:
Worst case scenario: Year 1 withdrawal under age 59½ from non-qualified annuity with gains:
Sometimes paying the surrender charge is the right move:
Run the math: compare surrender charge cost vs. benefit of accessing your money or moving to a better product.
Surrender charges are the price of liquidity restriction. They're not inherently bad—they're how the annuity business model works. But you need to understand them before committing money.
Ask yourself: "Can I afford to lock this money up for [X] years?" If the answer is "probably" or "maybe," you're not ready for an annuity.