Watch Out for Annuity Surrender Charges: How to Avoid Them

Annuities can supercharge your retirement savings, but there’s a potential downside. Nearly all annuities impose a surrender period, during which excessive early withdrawals are subject to a surrender charge.

With proper planning, however, you can easily avoid surrender charges. The key is knowing how much liquidity or access to funds you may need in your annuity.

That depends on your circumstances: how much you have in liquid savings, your other income sources, your health and how much spending flexibility you have.

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Kiplinger's Adviser Intel, formerly known as Building Wealth, is a curated network of trusted financial professionals who share expert insights on wealth building and preservation. Contributors, including fiduciary financial planners, wealth managers, CEOs and attorneys, provide actionable advice about retirement planning, estate planning, tax strategies and more. Experts are invited to contribute and do not pay to be included, so you can trust their advice is honest and valuable.

Some people need minimal unpenalized liquidity in an annuity. Retirees who have ample guaranteed income from employer pensions or IRAs and Social Security as well as good savings may need little flexibility.

Most financial experts recommend having the equivalent of several months' expenses in fully liquid savings or investments.

Many people, however, may need access to some of their funds for potential expenses, such as medical care or major home repairs, or even splurging on a new car or big vacation.

If you can’t afford to or don’t want to tie up any of your money, an annuity won’t be a good choice for you.

How surrender periods work

By understanding the surrender period and choosing annuities that provide sufficient access to your money, you can avoid surrender charges.

Here’s how the surrender period works for the most popular type of fixed-rate annuity, the multi-year guaranteed annuity (MYGA). Like a bank certificate of deposit, a MYGA pays a set guaranteed interest rate for a term of anywhere from two years to 10 years.

For instance, let’s say you have a seven-year MYGA that lets you take out 10% of the annuity value without penalty each year after year one. The surrender charge for any withdrawals above the allowed amount might start at 9% in year one and decrease by 1 percentage point each year after that.

There’s also usually a market-value adjustment, which essentially acts as an extra charge that can apply to early withdrawals if interest rates have gone up since you purchased the annuity.

If there’s a big interest-rate spike, the MVA could dwarf the usual percentage-based surrender charge.

While 10% penalty-free withdrawals are common, provisions vary. Some annuities may allow 5% to be withdrawn, and a few don’t allow any early withdrawals.

Make sure to understand the details before you buy. Sometimes you can get a higher withdrawal percentage in exchange for a slightly lower rate. That can sometimes be worth the peace of mind and greater financial flexibility.

If the annuity is in a traditional IRA, you may want sufficient penalty-free withdrawals to cover your required minimum distributions (RMDs), which start when you reach age 73.

Some annuities have enhanced withdrawal provisions, commonly referred to as living benefits, which waive penalties if you need to withdraw money for events such as an extended nursing home stay or a terminal illness.

'Laddering' also offers more access to funds

Laddering is a term originally applied to investing in bonds with different maturities. You can also stagger terms for MYGAs instead of putting all your money in one basket. Laddering can give you both good current income and future flexibility.

It also reduces the risk that you’ll ever be hit with a surrender charge, because once the term ends, the surrender charge of course no longer applies. You’ll get more frequent access to maturing funds without the possibility of penalties.

For example, you could create a ladder of MYGAs with three-, five- and seven-year terms. Then you’ll have complete access to about a third of your money three, five and seven years from when you created the ladder.

Three years from now, you’ll be able to roll those proceeds of the first annuity tax-free, via a 1035 exchange, into any other annuity that looks most attractive then.

If rates have moved higher, you’ll be able to get that new higher rate. The risk is that rates will have gone down in the interim — but you will have locked up most of your money in five- and seven-year annuities with higher rates.

But if you want or need the money then, you don’t have to do an exchange. If you decide to surrender your annuity (meaning cash it out), all of the accumulated interest you receive will count as taxable income, and if you’re younger than 59½, it’s normally subject to a 10% IRS penalty.

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The best laddering strategy depends in part on what the interest rate curve looks like at the time you’re creating the annuity ladder.

Today, the MYGA rate curve is flattish, so you won’t give up much income by putting some of your money in shorter-term annuities. You can get up to 5.85% on a three-year annuity, 6.05% on a five-year term, and 6.00% on a seven-year product as of May 2025.

Surrender periods apply to other types, too

Fixed indexed annuities have become popular in recent years. They often allow 10% withdrawals annually and have declining surrender penalties for the first seven to 10 years, and may allow access to funds through annuitization or optional income riders.

In general, they’re better suited for long-term goals than flexible cash access.

Variable annuities typically offer more access than indexed annuities. A few even allow unlimited penalty-free withdrawals. But, unlike fixed annuities, they are subject to market risk and frequently come with hefty ongoing fees.

If your variable annuity is mostly invested in stock funds, the value could be down when you need funds and you could take a loss, even if you don’t pay a surrender charge.

Finally, income annuities (deferred and immediate) have the least flexibility. You’ve placed your money with an insurance company in exchange for a current or future stream of guaranteed income.

I’m a strong advocate of income annuities, but anyone considering purchasing one should understand that they typically have no cash value and don’t permit withdrawals. In some cases, you may be able to move up the date when you begin receiving regular payments.

The bottom line: Plan not to pay

Paying a surrender charge amounts to giving away your money to the annuity company. Similarly, paying the IRS penalty for withdrawals before 59½ is a gift to Uncle Sam, who won’t even send you a thank-you note.

With proper planning, there’s no need to ever get stuck with either bill.

Ken Nuss is the founder and CEO of AnnuityAdvantage, a leading online provider of fixed-rate, fixed-indexed, and lifetime income annuities. Ken is a nationally recognized annuity expert and widely published author. A free rate comparison service with interest rates from dozens of insurers is available at www.annuityadvantage.com or by calling (800) 239-0356. There are no fees or charges for the firm’s services; 100% of the client’s money goes to work for them in their annuity.

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