Yes, you can cash out an annuity, but the cost depends on which type you own and when you do it
Most annuities can be cashed out before the contract ends, but you will usually pay a penalty. The amount you lose varies widely: some annuities charge a surrender fee that starts high and shrinks each year, while others let you withdraw a small percentage penalty-free annually. If you are under 59½, the IRS adds a 10% tax penalty on top of whatever your annuity company charges. The real cost only becomes clear when you look at your specific contract.
The reason annuities penalize early withdrawal is that you are breaking a promise to leave the money invested for a set period. The insurance company priced your annuity based on that commitment. Cashing out early means they lose the investment income they counted on, so they charge you to cover that loss.
Key Takeaways
- Surrender fees on annuities typically range from 5% to 10% in the first year and decrease by roughly 1% each year you hold the contract.
- If you withdraw money before age 59½, the IRS charges an additional 10% penalty on the taxable portion, separate from your annuity company's surrender fee.
- Some annuities allow you to withdraw a set percentage (often 10%) each year without penalty, which is called a free withdrawal provision.
- The total cost of cashing out can be 20% to 30% or more of your withdrawal in the first few years, depending on your age and contract terms.
How surrender fees work and why they decrease over time
A surrender fee is a penalty your annuity company charges when you withdraw more than your contract allows penalty-free. Most fixed and variable annuities have a surrender period — typically 5 to 10 years — during which this fee applies. In year one, the fee might be 10%. In year two, it drops to 9%. By year ten, it reaches zero.
The fee is calculated as a percentage of the amount you withdraw above the free withdrawal limit. If your annuity has a 10% surrender fee and you withdraw $50,000 when your free withdrawal is $5,000, the fee applies to $45,000, costing you $4,500. The fee goes to the insurance company, not the IRS.
Some annuities use a different structure: instead of a percentage, they charge a flat dollar amount or a percentage of your account value rather than your withdrawal. Read your contract's section on "surrender charges" or "withdrawal charges" to see which method yours uses.
The IRS 10% penalty if you are under 59½
If you withdraw money from an annuity before you turn 59½, the IRS charges a 10% penalty tax on the taxable portion of your withdrawal. This is separate from any surrender fee your annuity company charges — you pay both.
The taxable portion is usually the earnings (gains) in your annuity, not the money you originally put in. If you contributed $100,000 and your annuity grew to $150,000, only the $50,000 in earnings is subject to the 10% IRS penalty. You still owe regular income tax on those earnings as well.
There are narrow exceptions to the 10% IRS penalty: if you are disabled, if you withdraw money as part of a series of equal payments over your lifetime, or if you have a may have access to annuity (one funded through a 401(k) or IRA), some or all of the penalty may not explore. Your tax professional can tell you whether an exception fits your situation.
Free withdrawal provisions and how much you can take penalty-free
Many annuities include a free withdrawal provision that lets you take out a set percentage of your account value each year without triggering a surrender fee. This percentage is often 10%, though it varies by contract. If your annuity allows 10% free withdrawal and your account is worth $100,000, you can withdraw $10,000 per year without the surrender fee.
The free withdrawal amount resets each year. If you do not withdraw in year one, you cannot carry that 10% forward to year two and withdraw 20%. Each year stands alone. Some contracts let you withdraw your contributions (the money you put in) penalty-free at any time, even if you cannot touch the earnings without a fee.
Check your annuity contract for the section titled "free withdrawal" or "penalty-free withdrawal" to see what your specific contract allows. If you cannot find it, call your annuity company and ask: "What percentage can I withdraw each year without a surrender fee?"
What happens if you need money before the surrender period ends
If you are in the surrender period and need cash, you have three main options: use your free withdrawal provision, pay the surrender fee and the IRS penalty, or look for a 1035 exchange.
A 1035 exchange lets you move your annuity to a different annuity without paying the surrender fee or triggering the IRS penalty — but only if you move to another annuity. You do not get the cash; you straightforward transfer the contract to a new one. This makes sense only if the new annuity has better terms or lower fees. The new annuity will have its own surrender period, so you are not truly getting out of the commitment — you are moving it.
If you absolutely need the cash and have no other option, calculate the full cost first. Add the surrender fee, the 10% IRS penalty (if you are under 59½), and regular income tax on the earnings. Many people are shocked to learn that cashing out a $50,000 annuity in year one might net them only $35,000 or less after all penalties and taxes.
when ready annuities and deferred annuities have different cash-out rules
An when ready annuity (also called an income annuity) starts paying you right away and has no surrender period. Once you buy it, you cannot cash it out — you receive payments for life or for a set number of years, depending on your contract. Some when ready annuities have a refund feature that lets your beneficiary receive remaining funds if you die early, but you cannot access the lump sum yourself.
A deferred annuity is what most people think of when they hear "annuity." You invest money now, it grows, and you take withdrawals later. Deferred annuities have surrender periods and surrender fees. These are the ones you can cash out, though with penalties.
If you own an when ready annuity and regret the purchase, your only option is to sell it to a third party through a structured settlement company. This is a specialized market and you will receive less than the contract is worth, but it is the only way to convert the income stream back to cash.
How to find your annuity's cash-out terms
Your annuity contract is the only document that matters. It contains the surrender fee schedule, the free withdrawal percentage, the surrender period length, and any special provisions. If you cannot find your contract, call your annuity company and ask them to send you the current contract and a statement showing your account value, your remaining surrender period, and your available free withdrawal amount.
When you call, have your policy number ready and ask specifically: "What is my surrender fee if I withdraw money today?" and "How much can I withdraw penalty-free this year?" The company will give you exact numbers based on your contract and current account value.
If you are considering cashing out, also ask whether you can take a partial withdrawal instead of closing the annuity entirely. Some contracts allow you to withdraw part of your money and keep the rest invested, which may lower your overall penalty.
Frequently Asked Questions
What is the difference between a surrender fee and the IRS 10% penalty?
The surrender fee is charged by your annuity company and goes to them; the 10% IRS penalty is a tax that goes to the federal government. You pay both if you cash out before 59½. A surrender fee might be $5,000, and the IRS penalty might be another $3,000 on the same withdrawal — they are separate charges.
Can I avoid the surrender fee by waiting out the surrender period?
Yes. Once the surrender period ends (typically 5 to 10 years), you can withdraw your money without a surrender fee. You will still owe income tax on the earnings and the 10% IRS penalty if you are under 59½, but the insurance company's fee goes away.
What if my annuity lost money — do I still pay the 10% IRS penalty?
The 10% IRS penalty applies only to earnings, not losses. If your annuity is worth less than you put in, there are no earnings to penalize. You would owe tax and penalty only on any gains, if any exist. Consult a tax professional to calculate this correctly for your situation.
Can I cash out an annuity if I am disabled or facing a hardship?
The IRS allows penalty-free withdrawal if you are disabled, but you still owe income tax on the earnings. Hardship is not an IRS exception — the agency does not recognize financial hardship as a reason to waive the 10% penalty. Your annuity company might have its own hardship provisions, so ask them directly.
Is a 1035 exchange a good way to get out of an annuity?
A 1035 exchange avoids the surrender fee and IRS penalty, but you do not receive cash — you move to a different annuity. This makes sense only if the new annuity has significantly better terms or lower fees. If your goal is to get cash, a 1035 exchange does not help.