Careful consideration must be given to the possible consequences of closing a fixed annuity. By terminating the contract and taking a single lump-sum withdrawal, you will increase your taxable earnings for the year. Additionally, you may receive less than the actual balance in your account if you surrender your annuity too early.
Qualified Annuity Distributions
If your annuity is held in an IRA or company-sponsored retirement plan, none of the money within the account has been taxed. You received income tax deductions for each contribution and the growth remained tax-deferred. Closing your fixed annuity and taking the entire balance in a single lump sum will increase your taxable earnings for the year by the amount of the withdrawal. Distributions from annuities are taxed as ordinary income.
Non-Qualified Annuity Distributions
Annuities purchased with ordinary savings and not held within an IRA or group retirement plan are referred to as "non-qualified" and contain a mixture of previously taxed deposits and untaxed earnings. Closing a non-qualified fixed annuity results in a return of your after-tax contributions plus any new earnings. Only the growth is taxable at ordinary rates.
Early Withdrawal Penalties
Because annuities are tax-favored retirement investment vehicles, the IRS requires you to leave the money in the account until you are at least 59 1/2 years old. Closing your annuity before you're old enough probably will result in an early withdrawal penalty of 10 percent, in addition to the ordinary income taxes due. Only in certain situations might the IRS waive the penalty: total and permanent disability, excessive medical expenses, qualified higher education, first-time home purchases, IRS levies and distributions made as part of a series of substantially equal periodic payments.
Closing a fixed annuity can result in fees assessed by the insurance company, regardless of your age and separate from any IRS penalties. Most annuity contracts contain provisions permitting the insurance company to withhold a percentage of your account value if you terminate the plan before a specific number of years has elapsed. These fees are called surrender charges and typically range from 7 to 10 percent. Surrender penalties decrease annually, usually by 1 percent, until disappearing entirely.
Gregory Gambone is senior vice president of a small New Jersey insurance brokerage. His expertise is insurance and employee benefits. He has been writing since 1997. Gambone released his first book, "Financial Planning Basics," in 2007 and continues to work on his next industry publication. He earned a Bachelor of Science in psychology from Fairleigh Dickinson University.