What is an Annuity Surrender Charge?
It is very important to understand what is an Annuity surrender charge and the fees and penalties. It is usually the determining factor in the decision to purchase or not purchase an annuity.
During the surrender period of an Annuity, which is usually 10 years or less, you are allowed to withdraw the interest you have earned or up to 10% free withdrawal of your annuity value per year without any cost, penalty, or fee. If the withdrawal from your Annuity exceeds the contractually outlined free withdrawal amount, you may incur a surrender charge. The most common type of surrender charge is a fee based on a percentage of the amount you withdrawal from your annuity. It is common for this fee to decrease over the life of your annuity. This surrender charge percentage will typically decrease over a seven to ten year period, and then be eliminated completely.
An example of a seven-year surrender charge schedule would look like this. 8% In the first year, followed by 7% in the second year, then followed by 6%, 5%, 4%, 3% and finally 2% in the seventh and final year. In the eighth year of the Annuity in this example, the Annuity holder would not be charged a surrender fee for taking any size withdrawal from the Annuity.
Keep in mind that your surrender charge does not include any income tax you may pay, nor does it include any withdrawal penalty you may be charged if you are below the age of 59 1/2.
Let’s look at an example. Let’s say Mort purchases a $10,000 Annuity. The annuity agreement outlines an annual allowable withdrawal amount of 10% of the annuity value, and defines a surrender charge schedule of 8% in the first year, declining down 1% each year until it reaches 2% by the seventh year.
Mort creates his $10,000 Annuity and does not take any withdrawals from the annuity in year one.
In year two, Mort’s annuity has grown to $10,500 when he comes across a hot investment he would like to fund with $3000 currently sitting in his Annuity.
Mort reviews his surrender charge schedule and determines that he can withdraw up to 10% of his Annuity ($10,500 X 10% = $1,050) without penalty.
Any money over $1,050 will be subject to his second-year surrender charge schedule (6%).
Mort calculates that only $1,950 of his $3,000 withdrawal will be subject to a surrender charge ($3,000 withdraw amount – $1,050 allowable annual withdrawal = $1,950).
Mort is charged a surrender fee equal to 6% X $1,950 = $117.
Mort’s Annuity value after his withdrawal is $7,383. ($10,500 year two Annuity value – ($3,000 withdrawal amount + $117 surrender charge) = $7,383).
Next: Guide To Fixed Annuities
