How to Avoid Paying Annuity Surrender Charges

Annuities are an expensive product to issue. Their management costs are similar to those of any other investment, and their underlying insurance features require a full underwriting process as well. Add in the cost of broker commissions, and it can take years for the company to turn a profit on your annuity. If you want to recover your capital from the annuity during those early years, the company will levy stiff surrender charges to recover its costs. However, there are several ways to avoid or minimize these costs.

Step 1

Wait it out. You're only liable for surrender charges for a specified period set forth in detail in your annuity contract. If the fees reach zero after seven years and you've already held the contract for five, let your existing annuity continue for two more years before surrendering it.

Step 2

Withdraw your funds incrementally over a period of years. Most contracts allow you to withdraw 10 to 15 percent of your balance every year without penalty. Bear in mind, those withdrawals might be subject to taxation.

Step 3

Purchase a "no-surrender" or "level-load" annuity. These charge higher annual fees than conventional annuities, rather than a structure of declining surrender fees. If you want the option pulling out at any time, the tradeoff might be worthwhile.

Step 4

Re-allocate your investment capital. If your variable annuity is under-performing, change the underlying investment rather than surrendering the annuity itself. Most variable annuities charge little or no fee for that kind of internal transfer.

Step 5

Exchange your annuity for another one under Section 1035 of the tax code. If you switch to another annuity offered by the same company, they'll usually waive the surrender fees. This method also avoids triggering a tax penalty, a strong secondary benefit.

Tip

  • If you bought your annuity with after-tax dollars, your contributions aren't taxable when you withdraw them. "Qualified" annuities paid with pretax dollars are fully taxable, and so are any gains in your annuity. This is important because they're treated as ordinary income, rather than capital gains, and are taxed at a higher rate. All withdrawals are treated as taxable until you've exhausted the gains in your annuity. If you're below the age of 59 1/2 at the time of the withdrawal or surrender, the IRS will charge an additional 10-percent penalty on the taxable portion.

Photo Credits

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About the Author

Fred Decker is a trained chef and certified food-safety trainer. Decker wrote for the Saint John, New Brunswick Telegraph-Journal, and has been published in Canada's Hospitality and Foodservice magazine. He's held positions selling computers, insurance and mutual funds, and was educated at Memorial University of Newfoundland and the Northern Alberta Institute of Technology.

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