How To Avoid Paying The Surrender Fees On An Annuity

Every relationship has that first big step, the moment when you know you’re ready to commit. Getting into an annuity is also a big step when it comes to your retirement funds. Annuities are typically long-term commitments with expensive surrender fees and complicated feature options, but they can also be key to securing a retirement income.

Before you say, “I do,” to buying an annuity, make sure you know what you need to do in order to protect yourself and the money you need to rely on during your golden years.

HOW MUCH DO THEY COST?

Surrender fees can be scary because the charge is based on a percentage of the withdrawal amount. That percentage amount can be as high as 10 percent or as low as 1 percent. If you have $500,000 invested in an annuity, for example, then a 10 percent surrender charge would set you back by $50,000. Ouch. Nobody likes that.

These charges typically apply to withdrawals taken out of the account during the first six to eight years, and they are one-time fees, but surrender periods could last for as long as 10 years. The good thing is that these charges tend to go down the longer you hold the investment. For example, a surrender charge could start out at 8 percent in the first year that you hold the investment, and then decline by 1 percent every year until it eventually reaches zero.

ARE THERE EXCEPTIONS?

Because annuities are typically long-term contracts of five years or more, most companies allow investors free access to up to 10 percent of their principal, without assessing any surrender charges. That same $500,000 investment we talked about early could give you access to up to $50,000 a year in penalty-free withdrawals. Exceptions to this include the following:

  • You may be assessed additional penalties if you are in a variable annuity. Because variable annuities are market investments wrapped up in a life insurance package, investors pay fees on both the investment side and the insurance side. If you take out too much money, one or both sides may change the terms of your agreement and 1)lower your income payments, 2)limit your investment options, 3)cancel your growth rate or income guarantees.
  • If you are withdrawing retirement money BEFORE you reach the age of 59 ½, then the money is generally subject to a 10 percent tax penalty in addition to being taxed as ordinary income. These penalties are assessed by the IRS on money that has grown inside tax-deferred retirement accounts such as an IRA or 401(k).  

WHY DO COMPANIES CHARGE SURRENDER FEES?

The best way to understand why insurance companies charge surrender fees is to think about this commitment from their point of view. If you buy an annuity contract from an insurance company, then you are expecting them to pay you a regular income for a set period of time. In order to meet this obligation, the insurance company will need to invest this money in a way that can give them the most predictable returns.  

To achieve that goal requires long-term investing of large sums of money. The longer the term, and the larger the sum of money, the more predictable the numbers become. Insurance companies appreciate that, and so they may reward the investor with better terms the longer they are able to commit the money.

HOW TO AVOID PAYING THE SURRENDER FEES

If you know you need a certain amount of money for your income every month, and you know that an annuity can provide you with that income, one of the best things you can do from a planning standpoint is to set up an emergency fund. Most financial professionals recommend having at least three to six months of basic expenses set aside in the event of an unexpected emergency.

The best place for an emergency fund is a basic savings or money market account. You want this money to be easy to get to, and you don’t want it attached to a market investment or you may have to sell at a loss. Some financial planners advise laddering low-yield investments such as bank CDs that can give you a higher rate of return than a savings account. There are also fixed annuities that offer shorter investments periods of one to five years. Before you invest, have your specific needs analyzed by a financial professional.

Do you have questions about the fees inside your annuity? Are you worried about having access to your money? To have your portfolio analyzed by one of our retirement planning experts, drop us a line. We’d be happy to answer your questions about fees and to provide a cost analysis or comparison among the different income options available to you.

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