If you’ve tapped out your traditional retirement account options, like stocks and bonds in your IRA and 401k, an annuity might be the next best thing.
Annuities are insurance products, typically offered by life insurance companies. Under an annuity contract, the insurance company agrees to pay you regularly, with many contracts providing lifetime income.
At first glance, these products seem great. But, if you’ve signed up for one, you might have found that you don’t want to wait for a payout to come years down the road, or there may be some other reason you want to get out of your annuity. Unfortunately, these products aren’t very liquid, and getting out of them can be a challenge, but it’s not impossible.
Can I Get Out of an Annuity?
It’s typically possible to get out of any annuity you’d like. That is, if you’re willing to pay the penalty.
Annuities are designed to be long-term investments, regardless of the type of annuity you have. To hold you to your commitment, insurance companies charge surrender fees (early withdrawal penalties) if you access your money before it annuitizes (begins paying out per the contract).
Surrender charges typically start at around 10% and go down by 1% each year you hold your annuity. But this can vary from contract to contract, so read and understand the fine print on yours before committing.
The insurance company may not be the only party to impose fees if you cash out an annuity early. The IRS imposes tax consequences if the annuity is a tax-deferred investment product and you cash out before you’re 59½. The tax penalty is currently 10% on top of your ordinary income tax upon the withdrawal.
However, the tax penalty may not apply.
The 10% tax penalty only applies to gains, not your principal investment. So, if your annuity remained flat or even fell in value, you can cash it out completely without having to worry about any excess tax burden.
Keep in mind that annuities are on a last-in-first-out payment basis. That means profits are paid before any principal dollars. So, if you’ve made any profits at all and you cash out early, you will have to accept a 10% tax penalty on your realized gains.
The good news is that there are multiple ways to get out of an annuity, many of which help you avoid surrender charges and tax penalties altogether.
Should You Get Out of Your Annuity?
There are several factors that play into the decision of whether or not to try to get out of your annuity. Think about the following as you make the decision:
- How Badly Do You Need the Cash? Cashing in an annuity early is very expensive, but the cost of the cash may be null if the reason you need the cash is significant. For example, if you’re running on fumes and don’t have the money to keep your lights on in your house, cashing in may be worthwhile, regardless of the fees involved.
- Do You Have a Qualifying Event? You can cash in your annuity without penalty under very specific qualifying circumstances that are typically outlined in your annuity contract. For example, if you’ve been diagnosed with a terminal illness and you need the money to pay medical bills, you may be able to get out of your annuity without surrender charges or tax penalties.
- Where Are You in the Surrender Period? Surrender periods usually last several years and surrender charges typically shrink over time. For example, if you’ve had your annuity for six months, your surrender fee is probably 10%, but if you’ve had it for seven years, you may only have a 3% surrender charge. Make sure you know the fees before making your decision.
- Are You Comfortable With Your Retirement Savings? Annuities are designed to provide a stream of income throughout your retirement. If there are no extenuating circumstances, it’s probably not a good idea to give up this retirement income unless you’re certain your other retirement accounts are enough to keep you comfortable throughout your golden years.
The fact is that whether or not you should get out of your annuity is a decision that requires intimate knowledge of your unique financial situation. There’s no one-size-fits-all answer I could give to this question.
If you’ve asked yourself the four questions above and still aren’t sure if cashing in your annuity is a good idea, there’s no shame in seeking professional help. Get in touch with a certified financial planner (CFP) or financial advisor for one-on-one advice that takes your unique financial position into account.
How to Get Out of an Annuity
So, you’ve decided it’s time to get out of your annuity. What’s next?
You have several possible ways out. Some involve financial penalties, while others let you exit free and clear.
Penalty-Free Options
There are several ways you might be able to get out of your annuity without paying surrender charges.
Run Quickly
All annuities come with a free-look period. This is a short period of time you have to get buyer’s remorse out of the way and make sure you’re comfortable.
Free-look periods typically last between 10 and 30 days, depending on your location. If you cash out during this period, you won’t incur any penalties.
Take Advantage of Annual Free Withdrawals
If you only need a limited amount of money and can wait some time for the rest, take advantage of annual free withdrawals. Most annuities allow you to withdraw a certain percent of the annuity’s value each year. This could be enough to cover the reason you need the cash in the first place.
Buy the Right Type of Annuity
Some annuity products, called no-surrender or level-load annuities, don’t come with surrender charges at all. If you’re in the process of purchasing an annuity and are concerned about surrender fees, be sure to consider these options.
Exchange It
If you’re not happy with your annuity, but don’t need the cash right away, you may be able to exchange your annuity for a more competitive offer under Section 1035 of the U.S. Tax Code.
Be Patient
Of course, the most obvious way to get your money out of an annuity without paying surrender changes is simply to be patient. Once your annuity is annuitized, or matured, you can access your funds without threat of penalties.
Options That Involve Financial Penalties
If none of the options above work for you, don’t worry. You can still access your money, but you have to be willing to accept less than the total value of the annuity. You have two options in this case.
Surrender Your Annuity
Simply surrender the annuity. That means you breach the contract and get your cash. Of course, you may have to pay surrender charges that amount to up to 10% of your balance. But when you’re in a pinch, sometimes accepting a loss is your best option.
Your insurance company may also remind you of tax penalties in an attempt to keep you from surrendering your annuity. This argument may be null depending on the annuity’s growth. If the annuity has lost money, stayed flat, or only grown a little, tax penalties will be minimal. If your annuity has experienced substantial growth, do consider the potential tax liability before pulling the trigger.
Sell Your Annuity
Maybe you’ve heard the jingle, “It’s my money and I need it now!” J.G. Wentworth famously aired television commercials promising hard cash for structured settlements and annuities.
That’s right — you can also sell your annuity on the secondary market. In fact, this could be your only option if you have an immediate annuity, which isn’t as flexible as other types of annuities when it comes to early surrender.
Companies that purchase annuities give you a lump sum of the contract value minus their fees, which may or may not be less than the annuity surrender charges. Make sure you shop around and pick the option that costs you the least.
Final Word
Annuities are designed to provide guaranteed income later in life, but sometimes you can’t wait until later in life to tap into your annuity’s value.
If you’re considering cashing out your annuity, carefully consider your fee-free options. If you have to pay fees, think of how those fees will impact the lump sum you receive in the end and whether or not getting out early is worth it.
If you decide cashing out your annuity isn’t the best choice, consider other options for accessing funds. For example, a home equity line of credit may give you the money you need at a low interest rate, creating a situation where your problems are solved and payments are manageable.