Annuities are long-term insurance contracts that can generate predictable income for the future. But sometimes life gets in the way of savings plans, and you need cash now.
Maybe you’re facing a medical emergency, and you need to access money in an annuity contract before you originally planned.
Annuities can be cashed out in full, or you can take a partial withdrawal. But there are additional costs to consider when taking money out. Depending on the contract type and factors like the surrender period, penalties can include fees and tax obligations.
What happens if you withdraw from an annuity early?
Before diving into what the rules are for withdrawing from an annuity after signing, let’s consider the consequences. Here are two key issues to keep in mind.
Loss of future guarantees
Fixed annuities are meant as a long-term savings goal which can provide a guaranteed income stream in the future. When your contract value drops, the annuity can’t grow as planned or reach its full value. This loss can impact your long-term income strategy.
For example, suppose you’re using an annuity to guarantee predictable payouts in retirement. If you take out money early, your contract value dips and lowers future distributions. You may face a shortfall if the reduced income can’t cover essential expenses.
Immediate taxation
The IRS taxes most annuity withdrawals, fully or in part. Many annuity contracts grow tax-deferred, so taxes are postponed until amounts are withdrawn from the contract, which is generally at retirement. In addition, a withdrawal before age 59½ may also trigger an additional 10% federal tax on the taxable portion of the withdrawal). This penalty is separate from any surrender charge imposed by the insurer and from any market-value adjustment (MVA) the contract may impose during the surrender-charge period
Ways to access money in an annuity contract
There are several ways to access money in an annuity contract. Each has different tax, surrender-charge, and long-term-income consequences, and none is universally “lower cost” than another.
Free look
Every state requires that a new annuity contract include a free-look period during which the owner may cancel the contract penalty free and receive a refund. The length of the free-look period, how it is measured (typically from the owner’s receipt of the contract), and the refund method are set by state law and by the contract. Free-look periods are commonly 10 to 30 days, and some states require a longer period for consumers age 60 or older and for replacement transactions.
Most insurers refund your original investment, even if the account lost value during the free look period. However, some states only require issuers to pay the current market value of the annuity.
- Best for: New contract owners who reconsider the purchase within the applicable state free-look window.
- Primary tradeoff: Depending on your state and contract, you may receive only the current contract value, which can be less than what you invested.
Partial or “free” withdrawals
Most insurance companies allow you to withdraw a portion of your annuity value without a surrender charge (a “free” or “penalty-free” withdrawal amount). The permitted amount is set by the contract, commonly 10% of the contract value per year, but this amount can varies. So, for example, if the contract provides a “free withdrawal, and If you have $50,000 of contract value, you could take out $5,000 this year without a surrender charge. Withdrawals in excess of the contract’s free-withdrawal amount are subject to the contract’s surrender charge and, where applicable, a market-value adjustment.
The IRS will tax you on these withdrawals. A qualified annuity is funded with pre-tax dollars, so your entire withdrawal is taxed as ordinary income. (Qualified annuities held in a designated Roth account are taxed under the Roth rules.) A non-qualified annuity is funded with after-tax dollars, so only the earnings portion will be taxed.
Non-qualified annuities follow last-in, first-out (LIFO) rules for non-annuitized withdrawals. Interest comes out first and is taxable before principal. If your contract holds $100,000 and $6,000 is interest, a $6,000 withdrawal is fully taxable.
A pre-59½ non-qualified withdrawal is also subject to the 10% IRS tax penalty, unless a statutory exception applies.
- Best for: Consumers who need a limited amount of cash and want to preserve most of the contract’s long-term value.
- Primary tradeoff: You will pay income tax on the taxable portion (and potentially the 10% additional tax if under 59½), and the withdrawal reduces the contract value going forward.
Return of premium rider or waiver-of-surrender-charge feature
You can pay to add protections — riders — to your contract. Some annuity contracts include, or offer for an additional charge, a return-of-premium (ROP) feature or a waiver-of-surrender-charge rider.
An ROP feature typically guarantees that on surrender the owner will receive at least the greater of (a) the contract value or (b) total premium paid less prior withdrawals, so the owner’s premium is protected against loss to surrender charges, though contract earnings above premium may be reduced by any applicable surrender charge or MVA. Waiver-of-surrender-charge riders (e.g., for confinement to a nursing home, terminal illness, or disability) permit an early withdrawal without a surrender charge under the specific conditions described in the rider. Read the rider carefully for exact terms.
- Best for: Consumers whose contract includes such a rider and whose circumstances match the rider’s trigger.
- Primary tradeoff: Optional riders typically carry an additional charge and may not be available on all products or in all states.
Full or partial surrender with a surrender charge
Surrender periods can last up to 10 years after opening an annuity. During this time, you can’t take out money that exceeds the free-withdrawal limit unless you pay a penalty (a surrender charge, and where applicable, a market-value adjustment). Surrender fees are usually a percentage of the total value of your contract. These rates often start high and decline every year. For example, the penalty might be 10% during the first year and drop by 1% each year. Exact surrender-charge schedules are contract-specific.
- Best for: Consumers who need immediate access to a larger amount than the contract’s free-withdrawal amount permits and who have evaluated the alternatives.
- Primary tradeoff: You lose part of the contract value to the surrender charge and, if applicable, a market-value adjustment; the taxable portion is also subject to income tax and (if under 59½) the 10% additional tax under IRC §72(q)/(t).
Exceptions to the 10% federal additional tax
The following are new/expanded exceptions under SECURE 2.0 that may apply to a pre-59½ withdrawal from a qualified annuity or IRA (and, where indicated, a non-qualified annuity):
- Terminally-ill individuals: distributions to an individual certified as terminally ill are exempt from the 10% additional tax.
- Emergency personal-expense distribution: up to $1,000 once per calendar year for unforeseeable or immediate financial needs relating to necessary personal or family emergency expenses, without the 10% additional tax; may be repaid within three years.
- Domestic-abuse victim distribution: up to the lesser of $10,000 (indexed) or 50% of the account, without the 10% additional tax; may be repaid within three years.
- Federally-declared-disaster distribution: up to $22,000 per disaster, without the 10% additional tax; may be repaid within three years.
- Long-term-care insurance premium distribution: up to $2,500 per year from a qualified plan or IRA to pay premiums on qualifying long-term-care insurance, without the 10% additional tax.
- Age 59½, death, disability, substantially equal periodic payments.
How long does it take to withdraw from an annuity?
If you’re considering withdrawing from an annuity, it’s likely because you need quick access to your money. But the process isn’t immediate. Several factors affect how quickly you receive your contract proceeds:
- Insurer processing windows: Processing times vary by insurer but typically take a few weeks. An registered indexed linked or variable annuity may take longer. These annuities are linked to market performance, and the insurer will have to calculate the current value of the money in the contract before releasing it to you.
- Payout method: Electronic transfers are faster than paper checks and save you from waiting to receive and deposit the check.
- Additional approvals: If your annuity is held in a trust, the insurer may require notarized documents. How to evaluate a withdrawal decision
A decision to withdraw from an annuity should weigh the immediate liquidity need against the contract’s long-term features and the tax consequences. The considerations below are general; the right decision depends on the consumer’s specific facts and the specific contract’s term.
Liquidity
If you need quick access to your money, a partial withdrawal (within the contract’s free-withdrawal amount) or a partial surrender (above the free-withdrawal amount, incurring the surrender charge and any applicable MVA) may be options. A partial withdrawal is a good option if the amount is within the penalty-free limit. A full surrender ends the contract and forfeits all remaining guarantees. Beware of the tradeoff of early withdrawals. Each option reduces future annuity payments and can impact your retirement plan.
Reconsidering a recent purchase
Suppose you recently bought an annuity contract, and you’re reconsidering this investment purchase strategy. Check whether you’re still in the free-look period for your state and your contract. If you are, you can withdraw funds without a surrender charge (state-specific rules govern the refund amount).
Alternatives to fully withdrawing
Before you completely cash out an annuity, consider the alternatives. One option is taking a series of smaller withdrawals instead of fully surrendering your contract. This reduces the impact of a surrender charge and limits how much taxable income you face in a single year.
Another strategy is annuitization, which means converting the money in the contract into scheduled payments under one of the contract’s payout options (e.g., life-only, life with period certain, joint and survivor, period certain). This preserves long-term income and avoids a large taxable lump sum. Annuitization is generally irrevocable once elected.
A third option, if the withdrawal need is short-term and the contract permits, is to check whether the contract’s free-withdrawal amount alone can meet the immediate need.
Annuity cash-outs can provide access to money you need today but come with tradeoffs for tomorrow. Before making this or any other major financial move, weigh your options carefully.
Visit Gainbridge to learn more about annuity cash-out alternatives, check today’s rates, and use our calculator to model outcomes. Learn more about our Traditional and Retirement accounts and explore options that fit your timeline and goals
This article is intended for informational purposes only. It is not intended to provide, and should not be interpreted as, individualized investment, legal, or tax advice, and is not a recommendation to surrender or replace any annuity contract.
