How To Get Out of an Annuity You No Longer Want and Avoid Penalties
An annuity — a contract between you and an insurance company that requires the insurer to make payments to you, either immediately or in the future — is a good way to guarantee fixed income during retirement. You can buy an annuity by making either a single payment or a series of payments, and similarly, your payout may come either as one lump-sum payment or as a series of payments over time.
Trending Now: How To Get $340 Per Year in Cash Back on Gas and Other Things You Already Buy
Yet there are several reasons why you might not need one anymore. If you are considering taking a different path with your investments, here’s how to get money out of an annuity without penalty.
How To Get Money Out of an Annuity Without Penalty
Annuities are binding contracts, so your options for getting out of one are limited. However, it is doable, and you might be able to do it without paying a penalty.
Make a 1035 exchange
Use the crisis waiver
Cash out the contract
1. Make a 1035 Exchange
A 1035 exchange is a tax-advantaged way to switch annuities, and it lets you transfer funds from your current annuity to a new one without facing immediate taxes on gains, explained Jeff Rose, CFP and founder of Good Financial Cents.
According to Rose, this can be a smart move if you find an annuity with lower fees, better returns or features more aligned with your current financial goals.
Considering the expanded selection of annuities introduced by insurance companies in recent years, it’s certainly possible to find one that’s more suitable to your needs. “There are different levels of flexibility that are now offered that were previously not available,” Rona Guymon, senior vice president of Nationwide Annuity Distribution, said. She also added that annuity products have evolved, product development has progressed and interest rates have increased consumer value.
“The industry is more focused on being client-friendly than ever before and the interest rate environment is allowing annuities to provide more benefits than they have in the past,” she said.
While a 1035 exchange can get you into a better annuity, it’s important to remember that you might have to pay a surrender fee for terminating the existing contract. Also, exchanges can take several months to process, so it might not be the right choice if you need to get into a different annuity quickly, according to the American Armed Forces Mutual Aid Association.
That said, be wary of promises of a bonus or premium for making an exchange. “While this may sound like a good deal, variable annuities with bonus credits may have higher expenses that offset any gain,” the Financial Industry Regulatory Authority warned.
2. Use the Crisis Waiver
If you added a crisis waiver to your annuity contract, you might be eligible to cancel the contract in an emergency. When a triggering event occurs, such as a hospital stay, nursing home admission or terminal illness, you can use the waiver to access the funds in your account without incurring surrender charges, Guymon noted. Disability and unemployment can also trigger a crisis waiver, according to Annuity.org.
Although waivers and riders are usually different things, a crisis waiver can be a rider. EquiTrust Life Insurance Company, for example, calls its crisis waiver a “waiver of surrender charges rider.”
Read your contract carefully before attempting to use a waiver. Some only go into effect after you’ve had the annuity for a certain number of years or have reached a certain age, according to the McKennon Law Group.
3. Cash Out the Contract
If your annuity is still in its surrender period and you need out immediately, paying the surrender charge might be your only option, according to Rose.
“This fee, which decreases over time, can be substantial in the early years of the contract — I’ve seen charges in the 7-15% range. It’s a direct cost for accessing your funds early, but sometimes it’s worth it if staying in the annuity is more financially detrimental in the long term,” he said.
That can be true even if your reason for wanting out is that you’ve found an annuity that’s better suited to your needs and would qualify for a 1035 exchange. If the current annuity has not increased in value, for example, exchanging it provides no tax benefit. And if it has a market rate adjustment provision, you might wind up with less money than you’ll get if you cash out the policy, despite the surrender fee, the AAFMAA noted.
What Is the Best Way To Take Money Out of an Annuity?
Jeff Rose recommended checking to see if your annuity contract allows for partial withdrawals without big fees. Or without any fees.
“Many annuities let you take out a certain percentage each year, like 10%, without a surrender charge. This is a way to get some money without paying a lot in fees,” he said. “Remember, though, that taking money out can have tax impacts. Withdrawals are usually taxed as income, and if you’re under 59.5, you might also face an extra 10% tax penalty.”
Even if your annuity doesn’t allow for surcharge-free withdrawals, it might reduce the surrender charge each year you own the contract. Your contract might begin with a 7% surrender charge, for example, and then reduce the charge by 1% each year, according to CNN Money. This gradual reduction is another strategy for how to get money out of an annuity without penalty, with penalty-free withdrawals beginning in year eight.
FAQ
Here are the answers to some of the most frequently asked questions about annuities.
How do I avoid taxes on an annuity withdrawal?
You might not be able to avoid paying income tax on your withdrawal unless you funded the annuity with a Roth 401(k) or Roth individual retirement account. Roth accounts have after-tax contributions you've already paid tax on. Other funding sources are probably taxable when you make withdrawals, but you can, at least, avoid the 10% penalty tax for early withdrawals by waiting until you turn age 59.5 to make them.
Can I withdraw from an annuity without penalty?
Withdrawing from an annuity without penalty is possible if you use partial withdrawals, crisis waivers or a 1035 exchange to switch annuities. Always check your specific contract details to understand the available options and any associated conditions.
Yael Bizouati-Kennedy contributed to the reporting for this article.
This article originally appeared on GOBankingRates.com: How To Get Out of an Annuity You No Longer Want and Avoid Penalties
