How Does a Surrender Charge Work?
Surrender charges are assessed as fees when you cash out your annuity early. You will receive the amount that you cash out minus the surrender charge. The surrender period for these products varies, but for the most part, it is between six and eight years. After that point, you no longer have to pay a surrender charge. Some firms may waive these charges if the interest being offered on the contract falls below a certain level. As a rule of thumb, surrender charges reduce the value of, and the return on, an annuity. However, the fees don’t negate their full value. High-quality annuities that carry these charges may still be worth the money in some cases. If you have a long time horizon and are willing to live with less cash during the surrender period, they might be right for you. If you have a shorter time horizon and need the money soon, you may want to stay away from products that impose a surrender charge. After your surrender period ends, the charge no longer applies, and the firm that sold you your product will no longer be able to charge or assign fees if you decide to close it out. Fees for backing out of a financial contract early are most common with:
Deferred annuities (such as fixed, variable, and index annuities) Whole life insurance Class-B mutual funds
Immediate annuities are not subject to fees for short-term withdrawal, because they are designed to provide income right away.
Surrender Charge Amounts
The fees vary by the product, issuing firm, and how long you own the product. For the most part, the shorter the holding period, the higher the surrender fee. A surrender charge schedule depends on how much you take out. It starts as a percentage of the withdrawal amount in the first year you own the product and then falls by a specific percentage each year. After enough time has passed, it is entirely gone. For instance, you might be charged a 7% surrender fee if you withdraw funds from an annuity in year one, a 1% fee on amounts you withdraw in year seven, and no fee at all during or after year eight. Under this scheme, if you want to withdraw $10,000, you would pay $700 in year one versus only $100 in year seven. This means if you can afford to wait, you can save $600.
Why Do Firms Charge for Early Surrender?
Firms that sell financial products pass along these costs to the people who buy their products for a few reasons:
Offset operating costs: Firms need to recoup their administrative, operational, and sales costs by charging standard fees, but they lose these fees if you give up the product too quickly. Deter short-term use: Annuities are designed for long-term financial goals, such as retirement, rather than for short-term purposes, such as cash for a sudden surprise expense. Maximize returns: Firms want to be able to invest your money over the long term to gain higher returns.
What It Means for You
If you’re unsure about how or whether to invest in an annuity with surrender charges, work with a fee-only financial planner. They aren’t paid for selling products or given commissions, so you can be reasonably sure that the products they offer are in your best interests.
You Can Avoid a Surrender Charge
There are three main ways to forgo these fees. When choosing an annuity product with a surrender charge, ensure the perks outweigh the lack of liquidity. You might look to features such as the potential for income or long-term capital appreciation.
Hold past the surrender periodWithdraw smaller amountsTake advantage of fee waivers
Surrender charges are only imposed if you give up the product before the surrender period, which means you can avoid the fee by holding it past that period. You can find the precise date of the surrender period on your contract. Look for the fee schedule listed in the contract when you first buy it. Most annuity contracts have a free withdrawal provision that lets you take out a certain percent of the contract value, such as 10%, each year without incurring a surrender charge. You might be able to get the surrender charge waived in some instances, such as when:
Your spouse has passed away, and you collect survivor death benefits from an annuity You retire and take the required minimum distributions
These may appear on your contract as “crisis waivers,” or they may be in a section about IRS rules. Read the terms of your contract for the waiver details and learn the steps you need to take to get the fees waived.
