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A major advantage of annuities is the promise of a reliable, long-term cash flow. Once your annuity matures, you can elect to receive regular payouts to cover living expenses. But what if you need access to your money prior to maturity?
Although these funds are meant for long-term savings, you can withdraw before maturity. First, you’ll want to understand annuity withdrawal penalties and tax consequences so you know how they’ll affect your contract value.
Annuitization is when your annuity starts paying you a set amount on a regular schedule — monthly, quarterly, or annually. withdrawals are funds you take from your account value outside of those scheduled payments.
Annuitized funds are automatic and consistent, while withdrawals are flexible but unscheduled. The advantage of withdrawals is quick access to cash, though they may come with extra penalties and taxes depending on the timing and amount; they also reduce your account value and future annuitized payments.
Annuity penalties fall into two broad categories: fees your insurance provider charges (typically for withdrawing your funds prior to maturity) and charges from the IRS if you withdraw before you reach age 59 1/2. Here’s more on both types.
Insurance companies often set a surrender period for annuities, when you can't take out money early (before your term ends) without a charge. This penalty discourages early withdrawals, giving your account more time to grow.
Each contract has its own schedule and fees, but surrender charges usually decrease over time. They often start around 7% in the first year and drop by 1% yearly until they reach zero. But some contracts let you withdraw up to 10% of your portfolio each year without a surrender penalty.
Some insurance companies make exemptions and allow partial or full penalty-free withdrawals. There are also other charges you may be subject to, such as a market value adjustment, if you elect to take a withdrawal before your contract reaches maturity
Even if you don’t have a surrender charge or market value adjustment, the IRS will take a 10% penalty if you withdraw before the age of 59½. How the penalty applies to your withdrawal depends on if you have a qualified or non-qualified annuity.
Qualified annuities are funded with pre-tax dollars, like those in IRAs or 401(k)s, while non-qualified annuities use after-tax money. The IRS charges a 10% early annuity withdrawal penalty on the full amount of a qualified plan, but only on earnings for a non-qualified one.
Note that this penalty is separate from the income taxes you pay on annuity withdrawals. Even with a deferred annuity, you only avoid income tax until you begin taking withdrawals. Once your term ends and you receive funds, you have to pay the IRS taxes on ordinary income with every withdrawal. You’ll also have income taxes if you take funds out before 59½.
Note: A few annuity products on the market avoid this IRS tax penalty charge entirely, like Gainbridge®’s FastBreak™.
Whether an annuity withdrawal triggers penalty fees depends on when and how much you transfer from your account. While each contract has unique stipulations, many don’t enforce withdrawal penalties in the following scenarios.
The simplest way to avoid penalties is to wait until the surrender schedule ends — then, your insurance company won’t charge surrender penalties when you request any amount. To reduce penalties even more, wait until you reach 59½ — or purchase an annuity product that avoids these charges altogether, like FastBreak™.
Even during an annuity’s surrender period, the insurance company may let you withdraw a percentage without charges. For example, you might be able to take out 10% (the most common amount insurers allow) of your annuity’s value each year; however, if you are under 59 ½ you will be subject to an IRS early withdrawal tax penalty.
You can make penalty-free withdrawals if you meet the criteria for a qualified exemption in your contract. Qualified exemptions are situations where your insurance company waives withdrawal penalties, typically for major life events like terminal illnesses, new disabilities, and long-term stays in nursing facilities. And if you pass away before your contract annuitizes, your beneficiary may also make penalty-free withdrawals.
Riders are optional benefits you can add to your annuity contract, some of which offer penalty-free withdrawals in specific situations. For example, a long-term care rider provides penalty-free withdrawals if you’re in a nursing home or need at-home medical assistance however, if you are under 59 ½ you will be subject to an IRS early withdrawal tax penalty.
While some riders save you surrender charges, remember they cost extra in yearly fees.
At the end of your term, you can withdraw your entire annuity at once — penalty free however, if you are under 59 ½ you will be subject to an IRS early withdrawal tax penalty. To withdraw before then, consider how surrender fees and early withdrawal penalties affect your expected payout. After factoring in these costs, subtract income tax from your withdrawal, and you’ll get a sense of how much money you’ll receive.
Withdrawing an entire annuity at once means giving up your guaranteed future income. Instead of steady annuity payments, you'd have a single lump sum. Even if you can avoid penalties, consider whether losing reliable payouts and paying taxes is worth it before cashing out the full amount.
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