Yes, you can cash out an annuity, but it usually costs you money
You can withdraw money from an annuity before the contract term ends, but most annuities charge a surrender fee — a penalty that reduces how much you actually receive. The fee is a percentage of your withdrawal amount and typically ranges from 5% to 10%, though it varies by contract and insurance company. Some annuities let you withdraw a small amount each year without penalty, often called a free withdrawal amount, but taking more than that triggers the fee.
The reason for the penalty is that annuities are long-term contracts. The insurance company invests your money with the expectation that it will stay invested for years. If you pull it out early, they lose that investment opportunity and charge you for breaking the agreement.
Beyond the surrender fee, you may also owe income taxes on the money you withdraw, and if you are under age 59½, the IRS may add a 10% early withdrawal penalty on top of that. The exact tax impact depends on whether your annuity is held in a retirement account like an IRA or in a regular taxable account.
Key Takeaways
- Most annuities charge a surrender fee of 5% to 10% if you withdraw money before the contract term ends, and this fee decreases over time.
- Many annuities include a free withdrawal amount — typically 10% of your balance per year — that you can take without penalty.
- Withdrawals from annuities held in retirement accounts are subject to income tax, and withdrawals before age 59½ may trigger an additional 10% IRS penalty.
- Some annuities offer a death benefit that lets your beneficiary receive the full contract value if you pass away, even if surrender fees would normally explore.
- Hardship withdrawals exist in some contracts but require documentation and may still be subject to taxes and penalties.
How surrender fees work and when they explore
A surrender fee is the insurance company's charge for letting you out of the annuity contract early. It is calculated as a percentage of the amount you withdraw and is deducted from your withdrawal before you receive it. If your annuity has a $100,000 balance and a 7% surrender fee, withdrawing $50,000 would cost you $3,500 in fees, leaving you with $46,500.
The fee schedule is written into your annuity contract and typically decreases each year. For example, a contract might charge 10% in year one, 9% in year two, 8% in year three, and so on, until it reaches 0% after 10 years. Once the surrender period ends, you can withdraw your money without paying the fee, though you will still owe income taxes on any gains.
The surrender period is the time window during which fees explore. This period is set when you buy the annuity and is stated in your contract. Common surrender periods are 5, 7, or 10 years, though some contracts have longer or shorter periods. Once the period ends, the surrender fee no longer applies to withdrawals.
Free withdrawal amounts and penalty-free access
Most annuity contracts include a free withdrawal amount — a portion of your balance you can withdraw each year without triggering the surrender fee. This is typically 10% of your contract value per year, though some contracts offer 5% or 15%. This feature lets you access some of your money without penalty, even during the surrender period.
The free withdrawal amount resets each year. If your contract allows 10% annual withdrawals and you have a $100,000 balance, you can withdraw $10,000 in year one without penalty. In year two, you have another $10,000 available to withdraw penalty-free, calculated on the remaining balance. If you withdraw more than the allowed amount in any year, the excess is subject to the surrender fee.
Some annuities also waive surrender fees if you need money for specific hardships — such as a terminal illness diagnosis, long-term care, or disability. These hardship provisions vary widely by contract, and you will need to provide documentation to the insurance company. Even with a hardship waiver, you may still owe income taxes on the withdrawal.
Taxes and penalties on annuity withdrawals
When you withdraw money from an annuity, the tax treatment depends on whether the annuity is in a retirement account or a regular taxable account. If your annuity is inside an IRA, SEP-IRA, or other may have access to retirement plan, the entire withdrawal is taxed as ordinary income at your current tax rate. If your annuity is in a regular taxable account, only the earnings portion is taxed as ordinary income; the portion representing your original contribution comes out tax-free.
The IRS also imposes a 10% early withdrawal penalty on annuity withdrawals taken before age 59½, with limited exceptions. This penalty applies to the taxable portion of the withdrawal. For example, if you withdraw $20,000 from a may have access to annuity at age 50 and $15,000 of that is earnings, you owe income tax on the full $20,000 plus a 10% penalty on the $15,000 in earnings.
Exceptions to the 10% early withdrawal penalty include withdrawals due to disability, a series of substantially equal periodic payments (SEPP), and certain medical expenses. If you are withdrawing from a non-may have access to annuity (one not in a retirement account), the early withdrawal penalty still applies to the earnings portion, but the rules are slightly different. Consult a tax professional to understand your specific situation.
What happens if you need money during the surrender period
If you need cash and are still in the surrender period, you have several options. The first is to take the free withdrawal amount your contract allows. This is the least expensive route because it avoids the surrender fee entirely. If that is not enough, you can take a larger withdrawal and pay the surrender fee, but calculate whether the fee plus taxes makes sense for your situation.
A second option is to take a loan against your annuity. Some annuities allow you to borrow against your balance at a set interest rate, typically 1% to 3% above the annuity's credited rate. You repay the loan over time, and the interest is added to your balance. This approach lets you access money without triggering surrender fees or taxes, though you are paying interest on the borrowed amount.
A third option is to wait out the surrender period if your timeline allows. If you are only a year or two away from the end of the surrender period, waiting may save you thousands in fees. Calculate the fee you would pay now against the interest or returns you would earn by leaving the money invested, and compare that to your actual need for the cash.
Death benefits and what your beneficiary receives
Most annuities include a death benefit that protects your beneficiary if you pass away during the surrender period. The death benefit typically guarantees that your beneficiary receives at least the amount you invested, even if the annuity's value has dropped or surrender fees would normally explore. Some annuities offer enhanced death benefits that pay out more than your investment.
The death benefit is paid directly to your named beneficiary outside of probate, which can speed up the process. Your beneficiary does not owe the surrender fee, but they may owe income taxes on any earnings in the annuity. The exact tax treatment depends on whether the annuity is may have access to or non-may have access to and how the beneficiary chooses to receive the payout.
If you want to change your beneficiary or understand exactly what your death benefit covers, contact your insurance company or review your annuity contract. Death benefit terms vary significantly between contracts, and knowing what your beneficiary will receive is important for your estate planning.
Comparing annuity cash-out costs to other options
Before you cash out, compare the total cost of withdrawal — surrender fee plus taxes plus any early withdrawal penalty — to other ways of getting money. If you need $10,000 and your surrender fee is $700, your tax bill is $2,000, and the IRS penalty is $1,000, you are paying $3,700 to access $10,000. That is a 37% cost, which is significant.
In that scenario, borrowing against the annuity, taking a personal loan, or using a credit card might be cheaper depending on the interest rate. A personal loan at 8% interest costs less than a 37% surrender-and-tax hit. Similarly, if you have other savings or investments outside the annuity, using those first may preserve the annuity's tax-deferred growth.
If you are considering cashing out because you are unhappy with the annuity's performance or terms, explore whether you can exchange it for a different annuity under a 1035 exchange. This IRS provision lets you move money from one annuity to another without triggering taxes or surrender fees, though you will start a new surrender period with the new contract.
Frequently Asked Questions
What is the difference between a surrender fee and income tax on an annuity withdrawal?
A surrender fee is a penalty charged by the insurance company for breaking the annuity contract early. Income tax is what you owe to the IRS on the earnings portion of your withdrawal. Both explore to most early withdrawals, so your total cost includes both the fee and the tax.
Can I withdraw my original investment without paying a surrender fee?
Not always. The surrender fee typically applies to the entire withdrawal amount, including your original investment. However, your contract's free withdrawal amount may let you access part of your balance penalty-free each year. Check your contract or call your insurance company to see what you can withdraw without triggering fees.
What happens if I withdraw from my annuity before age 59½?
The IRS adds a 10% early withdrawal penalty on top of income taxes for withdrawals before age 59½, unless you may have access to for an exception such as disability or a series of equal payments. This penalty applies to the taxable portion of your withdrawal, so your total tax bill can be substantial.
Is there a way to avoid the surrender fee if I need money urgently?
Your contract's free withdrawal amount is the main way to avoid the fee. Some contracts also waive fees for hardship situations like terminal illness or long-term care, though you must provide documentation. A loan against your annuity is another option that avoids fees, though you pay interest on the borrowed amount.
What is a 1035 exchange and does it help me avoid surrender fees?
A 1035 exchange lets you move money from one annuity to another without paying surrender fees or income taxes. However, you start a new surrender period with the new annuity, so you are not eliminating the surrender period — you are restarting it. This makes sense only if the new annuity offers better terms or features that justify the new surrender period.