Yes, you can cash out most annuities, but the cost and process depend on which type you own and how long you've held it

An annuity is a contract with an insurance company, and like most contracts, you can end it early. The insurance company will give you money back — but not necessarily the full amount you paid in. If you're still in the surrender period (usually the first 5 to 10 years), the company charges a surrender fee, which can be 5 to 10 percent of your account value or more. After the surrender period ends, you can typically cash out with no penalty, though you'll owe income tax on any earnings. If you're under 59½, you may also owe a 10 percent early withdrawal penalty to the IRS on the earnings portion.

The exact rules depend on whether you own a deferred annuity (which grows tax-deferred until you withdraw) or an when ready annuity (which starts paying you right away). when ready annuities are much harder to cash out because the insurance company has already begun sending you payments based on your life expectancy. Deferred annuities give you more flexibility.

Key Takeaways

  • Most annuities charge a surrender fee if you cash out during the surrender period, typically the first 5 to 10 years you own the contract.
  • After the surrender period ends, you can usually withdraw your money without a company penalty, but you'll owe income tax on earnings and possibly a 10 percent IRS penalty if you're under 59½.
  • when ready annuities are difficult or impossible to cash out because the insurance company has already committed to paying you for life.
  • Some annuities offer a free withdrawal amount each year (often 10 percent) that lets you take money without a surrender fee.
  • If you need money urgently, selling your annuity to a third party (called a factoring company) is an option, but you'll receive less than the cash-out value.

How surrender fees work and what they cost

When you buy a deferred annuity, the insurance company locks in a surrender period — the years during which you cannot withdraw all your money without paying a penalty. This period typically runs 5 to 10 years, though some contracts extend to 15 years. The surrender fee is a percentage of your account value at the time you withdraw, and it decreases each year you hold the annuity. A common schedule might be 10 percent in year one, 9 percent in year two, and so on, reaching zero after 10 years.

The fee is charged by the insurance company, not the IRS. It's separate from income tax and the early withdrawal penalty. If your annuity is worth $100,000 and you cash out in year three with a 7 percent surrender fee, you lose $7,000 to the fee alone. You then owe income tax on the earnings portion of what remains, plus the 10 percent IRS penalty if you're under 59½.

Some annuities include a free withdrawal provision that lets you take out a set percentage each year — often 10 percent — without triggering the surrender fee. This is a built-in escape hatch for people who need access to their money. Check your contract to see if yours includes this feature.

Cashing out after the surrender period ends

Once the surrender period expires, you can withdraw your entire account value without paying the insurance company's surrender fee. This is a major milestone. However, you still owe taxes on the earnings portion of your withdrawal. If you contributed $50,000 and your annuity grew to $75,000, you owe income tax on the $25,000 gain.

If you're 59½ or older, that's the end of it — you pay ordinary income tax on the earnings and you're done. If you're younger than 59½, the IRS adds a 10 percent penalty on top of the income tax, but only on the earnings, not on your original contribution. Using the example above, you'd owe income tax plus 10 percent of $25,000 ($2,500) to the IRS.

The tax bill can be substantial, so many people don't cash out the entire annuity at once. Some take withdrawals over several years to spread the tax burden across multiple tax years. Others leave the money in the annuity and use only the income it generates.

Why when ready annuities are hard to cash out

An when ready annuity works differently. You give the insurance company a lump sum — say $200,000 — and in return, the company promises to send you a monthly or annual payment for the rest of your life. Once the payments begin, you cannot straightforward ask for your money back. The insurance company has already priced your payments based on life expectancy tables and invested your money accordingly.

Some when ready annuities do allow partial withdrawals or have a commutation option, which lets you cash out the remaining value in a lump sum. But this is rare and typically only available in the first few years. The amount you receive is calculated by the insurance company and is usually less than what you'd receive if you straightforward stopped taking payments and asked for the balance.

If you absolutely must exit an when ready annuity, your only real option is to sell it to a third-party buyer. This is discussed below.

Selling your annuity to a third party

If you need cash and cashing out directly would cost too much in fees and taxes, you can sell your annuity to a company that specializes in buying annuities. These are called factoring companies or structured settlement buyers. They purchase your right to future payments and give you a lump sum now.

The catch: you'll receive significantly less than the present value of your remaining payments. A factoring company might offer you $60,000 for an annuity that would pay you $80,000 over the next 10 years. They take the discount because they're taking on the risk and waiting for the payments themselves. The sale also requires court approval in most states, and the process takes several weeks to several months.

This route makes sense only if you're in genuine financial hardship and the surrender fee or tax bill would be even larger than the discount you'd accept. It's not a casual option — use it only after exploring other borrowing options, like a personal loan or line of credit.

Tax consequences of cashing out

The IRS treats annuity withdrawals using the last-in-first-out rule. This means earnings come out first and are taxed as ordinary income at your marginal tax rate. Your original contributions come out last and are not taxed again (you already paid tax on that money when you earned it).

If you're under 59½ and you withdraw earnings, you owe both income tax and a 10 percent penalty. There are a few exceptions to the penalty — if you're disabled, if you're taking substantially equal periodic payments, or if you're withdrawing after the annuity owner's death — but these are narrow. Most early withdrawals trigger the full penalty.

The tax bill is calculated on your personal tax return, not by the insurance company. The company will send you a 1099-R form showing how much you withdrew and how much was earnings. You report this on your return and calculate the tax owed.

Alternatives to cashing out

Before you cash out, consider whether you actually need the money or just need income. If you own a deferred annuity and you're retired or near retirement, you can start taking annuitization payments — regular monthly or annual payments for life — without cashing out the whole thing. This spreads your withdrawals over time and may result in a lower tax bill than a lump-sum withdrawal.

If you need a short-term loan, borrowing against the annuity (if your contract allows it) might be cheaper than cashing out. Some annuities permit loans at a set interest rate, and you repay the loan over time. This avoids the surrender fee and the when ready tax bill.

If you're struggling with cash flow, review whether you're taking full advantage of any free withdrawal provisions in your contract. Many people don't realize they can withdraw 10 percent per year penalty-free and straightforward don't use it.

Frequently Asked Questions

What happens if I cash out my annuity before 59½?

You'll owe income tax on the earnings portion plus a 10 percent IRS penalty on those earnings. If you're still in the surrender period, you'll also pay the insurance company's surrender fee. The total cost can easily be 20 to 40 percent of your withdrawal, depending on how much of your account is earnings versus your original contribution.

Can I withdraw money from my annuity without paying a surrender fee?

Yes, if the surrender period has ended or if your contract includes a free withdrawal provision (often 10 percent per year). After the surrender period ends, you can withdraw without the company's fee, though you'll still owe income tax on earnings and possibly the 10 percent IRS penalty if you're under 59½.

What's the difference between cashing out and annuitizing?

Cashing out means withdrawing a lump sum and ending the contract. Annuitizing means converting your account value into regular payments for life. Annuitizing typically results in a lower tax bill because you spread withdrawals over many years, and some of each payment is a return of your original contribution (which isn't taxed).

Can I sell my annuity if I need money urgently?

Yes, you can sell it to a factoring company, but you'll receive less than its value — typically 20 to 40 percent less. The sale requires court approval and takes several weeks to months. This option is best for genuine financial hardship when the surrender fee or tax bill would be even larger.

Do I have to pay taxes on my original contribution when I cash out?

No. You already paid tax on your contribution when you earned the money. Taxes explore only to the earnings your annuity generated. The insurance company will show on your 1099-R form how much of your withdrawal is earnings versus return of contribution.