What are surrender charges?

What are surrender charges?

Keep It Simple Answer: If you take out more than 10% of your annuity value in a given year, a penalty (surrender charge) will be applied to the amount in excess of the 10% penalty free withdrawal.

To answer this question in more detail let’s look at 2 examples

1)      A Fixed Rate Annuity

2)      An Indexed Annuity (also called Hybrid Annuities)

Annuities are long term contracts. You agree to deposit some money at the insurance company for a certain period of time.

The insurance company agrees to provide you the guarantees listed in the contract.

In order for the insurance company to provide you with those guarantees they need to invest your money in certain ways.

If you decide to break your end of the contract early, the insurance company needs to go liquidate some things in order to give you your money back and make sure they cover their expenses.

Another way to think of surrender charges would be “early exit penalty.”

Most annuities have a 10% free withdrawal feature. This means you can access up to 10% of your account value every year without any surrender charges or penalties.

But if you exceed that 10% withdrawal then there is a penalty on the excess. This is the surrender charge (or surrender penalty).

Here are 2 examples to show you what surrender charges are and how any penalties are calculated.

What are surrender charges in a 5 year fixed rate annuity? 

Surrender charge schedule example.

what are surrender charges

This is an example surrender charge schedule for a 5 year fixed rate annuity

Let’s say after 3 years your annuity is worth $100,000 and you decide to withdraw $25,000. So that’s a $15,000 excess withdrawal.

What is the penalty ?

  • You get 10% penalty free withdrawals so the first $10,000 comes out penalty free.
  • After the 3rd years the surrender charge is 4% on excess withdrawals. (See above chart)
  • So on the remaining $15,000 you will have a $600 surrender penalty. ($15,000 X 4% = $600)
  • So the total check you get back would be $24,400.

So you see. You have access to some of your money without penalty. If you exceed the 10% limit then there is a surrender charge on that excess amount. The amount of penalty depends on where you are at in the surrender charge schedule.

What are surrender charges in a 10 year indexed or hybrid annuity? 

10 Year Surrender charge schedule

what are surrender charges

This is an example of a 10 year surrender charge schedule from an index or hybrid annuity

Let’s use the same example. Let’s say after 3 years your annuity is worth $100,000 and you withdraw $25,000.

What is your surrender penalty?

  • You have 10% penalty free withdrawals so the first $10,000 comes out penalty free
  • After 3 years the surrender charge is 9% on excess withdrawals
  • So on the remaining $15,000 you will have a $1,350 surrender penalty. ($15,000 X 9% = $1,350)
  • So the total check sent to you after penalties would be $23,650

So what can we take away from here.

1)      If you need total access to you your money. Don’t put it into an annuity

2)      If you know you will need a big chunk of money that exceeds the 10% penalty free withdrawal, don’t put that money into an annuity

3)      As long you withdraw 10% or less of your account every year, you will never have any penalties on your withdrawals.

 

 

 

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