Annuities can be great investments for retirement savings and estate planning, but they come at a cost. If money is withdrawn from an annuity prior to the term of the contract, the insurance company usual⭕ly assesses a surrender charge for early withdrawal.

The Internal Revenue Service (IRS) may also assess a premature penalty of 10% and income tax on the withdrawn funds. The amount of the surrender charge depends on how long the owner stayed in the contract. The penalty for early withdrawal depends on the age of the contract holder and the 澳洲幸运𒐪5官方开奖结果体彩网:circumstances f💦or making the withdrawal.

In early January 2020, President Donald Trump signed the Setting ♛Every Community Up for Retirement E𓃲nhancement (SECURE) Act. Part of the act is expected to make annuities more popular. First, the act created a “fiduciary safe harbor” that lowers the risk that a plan participant will have to sue a plan fiduciary if💃 the insurance company cannot pay on the annuity as promised.

Additionally, annuities sold inside qualified plans are now more portable. If the annuity option is taken out of the plan, the participant can roll it out of the plan “in-kind” rather than having 🍎to li🃏quidate the option.

Annuity Surrender Charges

Annuity contracts are issued by insurance companies for a specified investment term, typically from four to eight years. Also known as the 澳洲幸运5官方开奖结果体彩网:accumulation phase, this is the period during which your initial lump sum is supposed to grow, accumulating the funds that will be paid out to you later in the 澳洲幸运5官方开奖结果体彩网:annuitization phase. This means that any 澳洲幸运5官方开奖结果体彩网:withdrawal you make during this period incurs a surrender charge.

For each year the investment is held, the penalty for early withdrawal changes, decreasing lower the longer the annuity is held. This is called a surrender schedule. It is not uncommon for an early withdrawal penalty made in the first few years of owning an annuity to exceed 5%. For example, an annuity with an investment term of eight years might have a 澳洲幸运5官方开奖结果体彩网:surrender charge of 8% in year 🐠one after you sign up, 7% in year two, and ♑so on, dropping one percentage point annually until year eight.

Tax Penalties on Annuities

In addition to penalties assessed by the insurance company, early withdrawals may also trigger an IRS penalty—specifically a 10% 澳洲幸运5官方开奖结果体彩网:withdrawal penalty, the same fee levied on early distributions from a 401(k) or 澳洲幸运5官方开奖结果体彩网:individual rꦡetirement account (IRA).

Why? Annuities are considered a retirement product by the IRS regardless of whether or not the contract is held in a qualified retirement plan (which 澳洲幸运5官方开奖结果体彩网:usually isn’t a good idea, anyway). Even non-qualified annuities (those purchased with after-tax dollars and not held in a retirement account) require the owner to reach the age of 59½ before taking penalty-free distributions.

The 10% penalty applies to the earnings portion of a withdrawal—which doesn’t sound too bad, except that, when it comes to annuities, the IRS assumes that earnings are withdrawn first (not your original investment).

Exceptions to Annuity Penalty Rules

Fortunately, like retirement accounts, annuities allow for early withdrawal with no penalty in the event the annuitant becomes disabled or dies. Additionally, some contracts offer a benefit for taking penalty-free withdrawals to pay for long-term care expenses.

Many annuity contracts also let the owner wit🧜hdraw up to 10% of the contract value or premium each year, as defined in the contract, penalty-free.

The Bottom Line

Annuities can be great for retirement savings and estate planning, but withdrawals can trigger one of two types of penalties. The insurer issuing the annuity assesses surrender fees if funds are withdrawn during the annuity’s accumulation phase, and the IRS charges a 10% early withdrawal penalty and income tax on the withdrawn funds if the annuity holder is younger than 59½.