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Layin’ It on the Line: What are the surrender penalties in an annuity?

By Lyle Boss - Special to the Standard-Examiner | Feb 7, 2024

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Lyle Boss

Surrender, in the context of annuities, refers to the act of terminating the annuity contract and receiving the remaining value of the contract in a lump sum, rather than receiving future payments. Surrendering an annuity may result in a surrender charge, which is a fee imposed by the insurance company for early termination of the contract.

Like other financial products, annuities have surrender penalties to discourage policyholders from withdrawing funds before maturity. This is because annuities are long-term financial products designed to provide a stream of income, usually during retirement. The insurance company needs to have a steady flow of money from policyholders’ premiums to make payments to those withdrawing cash from their annuities. Suppose policyholders were allowed to withdraw their funds without penalty. In that case, they may be more likely to do so, negatively impacting the insurance company’s ability to make payments to other policyholders.

Additionally, surrender penalties are used to fund the guarantees and benefits promised in the annuity contract, such as death benefits, minimum interest rate guarantees and other promises. These guarantees and benefits come with a cost, and the insurance company needs to recover that cost by imposing surrender penalties on policyholders who withdraw their funds early.

There are several ways to avoid surrender penalties when buying an annuity:

1. Choose an annuity with a shorter surrender period: Some annuities have shorter surrender periods than others, which means that the policyholder will be subject to a penalty for a shorter period if they think they might need to withdraw their funds early.

2. Look for annuities with no surrender penalties: Some annuities, such as shorter-term contracts, might allow for early withdrawal.

3. A free withdrawal annuity is a type of annuity contract that allows the holder to make withdrawals of a portion of the contract value without incurring any surrender charges or penalties. This type of annuity is designed to provide flexibility and liquidity, as the holder can access their funds as needed without having to completely surrender the contract. However, it’s important to note that free withdrawals may be subject to other conditions, such as limitations on the frequency or amount of withdrawals, or restrictions on the use of the funds withdrawn. Withdraw funds only during a “free withdrawal” period: Most annuities have a “free withdrawal” period, during which the policyholder can withdraw a certain percentage of their funds without penalty. Normal withdrawal limits without penalty is 10% per year of the account value.

4. Consider riders or options that waive penalties for specific events: Some annuities have riders or options that waive penalties for events such as the annuitant’s death, terminal illness or nursing home confinement.

It’s important to remember that these options may come with trade-offs, such as lower interest rate guarantees, so it’s essential to weigh the pros and cons before deciding. It’s also important to read the annuity contract carefully, understand the terms and conditions of the surrender penalties before purchasing an annuity, and consult a financial advisor or an annuity professional.

Lyle Boss, a native Utahn, is a member of Syndicated Columnists, a national organization committed to a fully transparent approach to money management. Boss Financial, 955 Chambers St., Suite 250, Ogden, UT 84403. Telephone: 801-475-9400.


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