What Is a Surrender Charge on an Annuity?

A surrender charge is the fee the contract takes if you take out more than the free withdrawal, or if you leave, before the surrender period ends. When that period ends, the charge can go to zero. The income base, the rider fee, the death benefit, and the tax do not reset because the calendar page turned.

People treat the end date as a deadline to move. It is the date the exit gets cheaper. The decision is still the same one on the annuity review page: is the guarantee worth more than leaving?

What actually changes

1. The surrender charge schedule hits its last year. Find the contract date and the year-by-year charge. “Almost over” can still mean 2 percent or 3 percent this month. Zero is a number on the schedule, not a feeling.
2. A full exit no longer pays that charge. You can surrender or exchange without the penalty that applied in year three or year five. Other costs remain.
3. The free-withdrawal limit stops being the ceiling. During the period, many contracts allow a free withdrawal, often a set percent of the account value each year. After the period, that cap is no longer the reason you cannot take more. Tax can still apply to what you take.

What does not change

• The income base. If the statement shows an income base above the account value, that higher number does not convert to cash because the charge ended. It is still a figure used to calculate a future payment.
• The rider fee. The annual charge for an income rider or a death benefit keeps coming out until you cancel the rider or leave the contract.
• The death benefit. Some contracts pay a beneficiary more than the account value. Leaving can replace that with a new benefit that starts over.
• The tax. Ending the surrender period is not a taxable event by itself. Cashing out a non-qualified annuity generally taxes the gain as ordinary income in that year. An annuity inside an IRA follows the IRA rules. A 1035 exchange can defer tax and still start a new surrender period on the new contract.

A simple example

These numbers are hypothetical. They are not a quote.

The contract date was seven years ago. The schedule says the surrender charge is 0 percent this year. Account value: $180,000. Income base: $240,000. The income rider still costs 1 percent of the income base, about $2,400 a year.

Last year a full exit would have cost a surrender charge of about $9,000. This year that charge is $0. The owner who surrenders may receive about $180,000 before tax, and the $240,000 income base is gone. If the annuity is not inside an IRA, the gain over what they paid is generally taxed as ordinary income.

The charge going to zero saved the $9,000. It did not make the income base worth less, and it did not make the tax zero. A replacement that starts a new seven-year surrender period puts a charge back on money that is finally free of one.

What changes the answer

• You are about to turn income on. The income base matters more when a payout is close. It matters less when the rider will never be used and the fee still comes out.
• Someone proposed a replacement in the same month the charge hit zero. Ask what new surrender period starts, and which riders you lose. The timing is a sales window as often as it is a planning window.
• You only need some of the money. A partial withdrawal after the period can be cheaper than a full surrender, and it can leave the rider in place. Check whether a withdrawal reduces the income base.
• The contract is a bonus annuity. A bonus credited in year one is sometimes earned out over the surrender period. Read whether any remaining bonus is pulled back at the end. Do not assume the end date forgives it.

The common mistake

Marking the end date as the day you must move. The second mistake is a new contract signed because the old charge is gone, without reading the new charge schedule. You can be free of a surrender charge on Monday and locked into a new one on Friday.

Questions to ask when the period ends

• What is the surrender charge, in dollars, if I leave this month?
• What is the account value, and what is the income base?
• What do I still pay each year for riders?
• If I take a partial withdrawal, what happens to the income base?
• If I exchange it, how many years is the new surrender period?
• What is the tax if I cash out, and is this contract inside an IRA?

When a review helps

Ask for a review when the charge is about to hit zero or just did, and someone has sent a replacement illustration. Bring the contract and the latest annual statement.

The fee lines that remain after the charge ends are in Annuity fees and charges. The eight checks before a move are in Should I keep my annuity or move it?.

If you want that comparison before you sign a replacement, request an annuity review.