Can You Take Money Out of an Annuity?

An annuity represents a contract with an insurance company, primarily designed to provide a steady income stream, often for retirement. These financial products serve as long-term savings vehicles, allowing invested funds to grow on a tax-deferred basis. While annuities are structured for future income, accessing the accumulated value is possible, though it involves specific methods and financial considerations.

Understanding Annuity Withdrawal Options

Annuity holders have several distinct ways to access the funds within their contracts, each with different implications for income and control. One common method is annuitization, which converts the accumulated value into a guaranteed stream of regular payments. These payments can be structured for a fixed period, for the lifetime of a single individual, or for the joint lifetimes of two individuals. The specific payout option chosen determines the payment amount and duration.

Another approach is systematic withdrawals, which allow for a series of planned, periodic payments. With this method, the annuity contract remains in force, and the remaining balance continues to accrue interest or investment gains. These withdrawals offer flexibility, as the annuity owner typically sets the payment amount and frequency, without fully converting the contract into an income stream.

Partial withdrawals or lump-sum withdrawals provide additional flexibility. A partial withdrawal involves taking out a portion of the annuity’s value as a one-time or irregular payment, leaving the rest of the funds within the contract to continue growing. A lump-sum withdrawal involves taking out the entire remaining value of the annuity in a single payment, effectively terminating the contract. Both allow direct access to accumulated funds, differing primarily in the amount withdrawn and the impact on the contract’s continuation.

Tax Treatment of Annuity Withdrawals

The tax implications of withdrawing funds from an annuity depend on whether the annuity is non-qualified or qualified. Non-qualified annuities are purchased with after-tax dollars. When withdrawals are made from these annuities, earnings are generally taxed as ordinary income, while original contributions are returned tax-free. This tax treatment follows the “Last-In, First-Out” (LIFO) rule, which dictates that earnings are considered to be withdrawn first.

For example, if a non-qualified annuity has accumulated earnings, any withdrawals will be treated as taxable income up to the total amount of those earnings. Only after all earnings have been distributed will subsequent withdrawals be considered a tax-free return of the original contributions. This LIFO rule impacts the immediate tax liability of withdrawals.

Qualified annuities are typically funded with pre-tax dollars, often as part of a retirement plan like an Individual Retirement Account (IRA) or a 403(b) plan. The entire amount of any withdrawal, encompassing both contributions and earnings, is generally taxed as ordinary income. Since contributions were not previously taxed, the full distribution becomes subject to income tax upon withdrawal.

Tax rules can also vary based on the age of the annuitant, particularly for qualified annuities. After reaching age 73, individuals with qualified annuities typically become subject to Required Minimum Distributions (RMDs) annually. These RMDs mandate that a specific portion of the annuity’s value must be withdrawn each year to avoid a penalty. The calculation of RMDs is based on the account balance and life expectancy tables provided by the Internal Revenue Service.

Penalties and Exceptions for Early Withdrawals

Withdrawing funds from an annuity before age 59½ can trigger an additional federal tax penalty, designed to discourage short-term savings. Generally, withdrawals made from annuities before age 59½ are subject to an additional 10% federal income tax, on top of any regular income tax due on the taxable portion. This penalty applies to both non-qualified and qualified annuities, unless a specific exception is met.

Several specific exceptions exist to this 10% early withdrawal penalty, allowing access to funds without the additional tax. One common exception applies to withdrawals made after the death of the contract holder. If the beneficiary receives the annuity proceeds, the 10% penalty is typically waived.

Another exception covers withdrawals made due to the annuitant’s disability, provided the disability meets the Internal Revenue Service’s definition of total and permanent. Additionally, withdrawals that are part of a series of substantially equal periodic payments (SEPPs) are exempt from the 10% penalty. This strategy involves taking regular, fixed payments for at least five years or until age 59½, whichever is longer, calculated using specific IRS-approved methods.

For qualified annuities held within employer-sponsored plans, such as 401(k)s or 403(b)s, an exception allows withdrawals without the 10% penalty if the individual separates from service with their employer at age 55 or older. Withdrawals used to pay for unreimbursed medical expenses that exceed 7.5% of the taxpayer’s adjusted gross income can also be exempt from the 10% penalty. These exceptions provide pathways to access annuity funds without incurring the additional tax.

Annuity Surrender and Loans

Beyond regular withdrawals, an annuity holder can also access the contract’s value by surrendering it entirely or by taking a loan. Surrendering an annuity means terminating the contract completely and receiving the remaining cash value. This action often incurs surrender charges, which are fees imposed by the insurance company for terminating the contract before a specified period, typically ranging from six to ten years after purchase. These charges can significantly reduce the amount received upon surrender.

When an annuity is surrendered, any gains in the contract are subject to ordinary income tax, and if the annuitant is under age 59½, the 10% early withdrawal penalty may also apply to the taxable portion. The calculation of the taxable gain follows the same LIFO rules as partial withdrawals for non-qualified annuities. Surrendering an annuity can result in a substantial reduction of the principal due to combined surrender charges, income taxes, and potential penalties.

Some variable annuities may offer the option to take a loan against the contract’s cash value. These loans allow the annuity holder to borrow a portion of their accumulated value without fully surrendering the contract. Interest typically accrues on the loan, and repayment terms are established. If the loan is not repaid, it can reduce the annuity’s cash value and death benefit.

Annuity loans are generally not available from fixed or indexed annuities. The availability of a loan option is a feature specific to certain variable annuity contracts. While a loan can provide immediate liquidity without fully liquidating the annuity, it is important to understand the interest costs and the potential impact on the contract’s value if the loan is not repaid as scheduled.