Annuities can be a valuable retirement planning tool, offering guaranteed income streams and tax advantages. However, situations change, and sometimes you might find yourself needing access to the money you’ve invested in your annuity. There are a few ways to get out of an annuity, but each option comes with its own set of costs and considerations.
Here’s what you need to know.
4 ways to get out of an annuity
It takes a lot of money to buy an annuity (think $100,000 and up). While these financial products are designed to provide a reliable paycheck in retirement, locking up so much cash can leave some annuity owners searching for a way out of their restrictive contracts.
There are four ways to get your money out of an annuity, but none of them involve getting your entire investment back at no cost. To access more than 10 percent of your annuity’s value, you’ll face fees and taxes, making the entire process complicated as well as expensive.
1. Pay the surrender charge
Most annuity companies allow you to cash out, or surrender, the contract for its current value, or withdraw a portion of the accumulated funds before income payments begin. However, surrender charges will be deducted from the amount you receive.
Paying the surrender charge to access your annuity is the most straightforward option, but also potentially the most expensive.
Most surrender charge periods last six to eight years from the purchase date. Surrender charges can be substantial, often around 7 percent or higher in the initial years of the contract, then gradually decreasing as the surrender period progresses.
And if you’re under age 59½, you’ll also face a 10 percent penalty from the IRS for withdrawing money from an annuity. This penalty is similar to those imposed by 401(k)s, IRAs and other tax-advantaged retirement accounts.
Some annuity contracts offer crisis waivers. These waivers suspend surrender charges in specific situations, such as terminal illness or confinement in a nursing home. If you anticipate needing to access your annuity funds before the surrender period is up due to situations like that, ask about a crisis waiver before signing the annuity contract.
2. Withdraw options
Some annuities offer limited withdrawal provisions that allow you to take out a portion of your money penalty-free. These are often capped at a specific percentage of the account value each year — typically 10 percent — or a flat dollar amount.
However, exceeding the annual withdrawal limit can still incur a penalty, even after the surrender period ends.
Review the details of your annuity contract to see if it includes a free withdrawal provision and make sure you understand the terms and conditions.
3. 1035 exchange
This strategy involves exchanging your existing annuity for a new one without incurring immediate tax penalties. Think of it as a trade-in.
This can be a viable option if you’re unhappy with your current annuity’s terms but still want the benefits of an annuity product.
However, there are caveats. First, surrender charges might still apply to the original annuity. Second, the new annuity might have its own fees and surrender period. So the surrender period on the new annuity restarts, potentially trapping you in another surrender charge window.
Not all annuities qualify for a 1035 exchange, so check with your life insurance company for eligibility.
4. Sell a portion of your payments
This option involves selling your future income stream from the annuity to a third-party company in exchange for a lump sum payment upfront.
The amount you receive will depend on multiple factors, including your age, health and the size of your annuity payments.
You’ll receive a discounted amount compared to the total value of your future payments, and you’ll give up control over some or all of your guaranteed income stream in retirement.
The discount rate plays a key role in determining the payout you’ll receive. Annuity buyers, known as factoring companies, set their own discount rates. This discount reflects the trade-off you make for immediate access to your money. It also allows the purchasing company to make a profit on the transaction.
Higher discount rates translate to lower payouts for you. For example, a 10 percent discount rate is better than a 15 percent discount rate.
To maximize the value you receive, it’s crucial to compare quotes from multiple annuity buyers. Shop around and find the factoring company offering the most favorable terms so you can minimize the discount applied and maximize your cash payout.
Reasons why you might want to get out of an annuity
Annuities are meant to be long-term financial products, so they’re specifically designed to discourage people from taking early withdrawals.
However, there are several reasons you might consider leaving your annuity.
- Major life event or change in plans: Unexpected medical bills, job loss or a change in your retirement timeline may make it necessary to access your funds sooner than expected.
- Fees and expenses: Some annuities come with high fees that eat into your returns. If you find a better investment opportunity with lower costs, exiting your annuity might be worthwhile.
- Performance concerns: If your annuity isn’t performing well compared to other investment options, you might want to explore alternatives.
If you recently signed your annuity contract, you might have another way to get out of the agreement.
The “free look” period is a buyer-protection provision for annuities. It gives you a short window, usually 10 to 30 days after receiving your annuity contract, to review its details.
If, after review, you decide the annuity isn’t right for you, you can cancel the contract. By canceling within the free look window, you’ll receive a full refund of your initial premium payment. There won’t be any deductions or penalties applied.
Frequently asked questions
Surrender charges can make early withdrawals expensive. Penalty-free withdrawal options and 1035 exchanges offer better terms, but have limitations.
Yes. Once you’ve begun receiving income payments through annuitization, you generally can’t cancel the contract and access the remaining principal. This applies to immediate annuities and deferred income annuities that have entered into the payout phase.
While some withdrawal options exist, they often come with limitations. You might only be able to take a portion of the full value out, for example, and that amount could be reduced by taxes, surrender charges and even discount rates, depending on the withdrawal method you choose.
Bottom line
Exiting an annuity can be complex. Carefully consider the costs involved, including surrender charges, taxes and potential lost income. Speak with a financial advisor to understand the best course of action for your specific situation.
