Can You Take Money Out of an Annuity?

An annuity is a contract with an insurance company, designed for retirement savings and income. Individuals contribute funds that grow on a tax-deferred basis. Understanding how and when to access these funds is important, as various financial implications are associated with withdrawals.

Methods for Accessing Annuity Funds

Accessing funds from an annuity can occur through several distinct methods, each offering a different approach to utilizing the accumulated value.

One common method involves annuitization, where the annuity balance is converted into a series of regular, periodic payments. These payments can be structured to last for a specified period, such as 10 or 20 years, or for the remainder of the annuitant’s life. Once an annuity is annuitized, the decision is generally irrevocable.

Another option for accessing funds is through partial withdrawals, which allow the annuity holder to take out specific amounts while the remaining balance continues to grow. Many annuity contracts permit partial withdrawals up to a certain percentage of the account value annually, often between 5% and 10%, without incurring additional charges from the insurance company.

Individuals may also choose a full surrender, which entails withdrawing the entire accumulated value of the annuity and effectively terminating the contract. This action provides immediate access to the entire sum, but it also means foregoing any future growth or income potential from that annuity.

Some specific types of annuities may offer the possibility of taking a loan against the accumulated value. This feature is not universally available across all annuity products and is typically found in certain variable annuity contracts. Such loans generally require repayment with interest, and failure to repay could result in the loan amount being treated as a taxable distribution.

Taxation and Penalties on Annuity Withdrawals

Withdrawing money from an annuity involves specific tax implications and potential penalties that can affect the net amount received.

Earnings, or the growth within a non-qualified annuity, are generally taxed as ordinary income upon withdrawal, not as capital gains. The Internal Revenue Service (IRS) typically applies a “Last-In, First-Out” (LIFO) rule for non-qualified annuities, meaning earnings are taxed first until all gains are exhausted. For qualified annuities, which are funded with pre-tax dollars, the entire withdrawal amount is typically taxed as ordinary income.

In addition to ordinary income tax on earnings, withdrawals made from an annuity before the owner reaches age 59½ may be subject to an additional 10% early withdrawal penalty imposed by the IRS, as outlined in Internal Revenue Code Section 72. This 10% penalty is applied to the taxable portion of the withdrawal.

Insurance companies also impose fees for withdrawals or full surrenders made during an initial “surrender period.” This period typically lasts for a set number of years, commonly ranging from five to ten years, from the date the annuity contract was established. Surrender charges are a percentage of the amount withdrawn or the accumulated value, and this percentage usually declines over the surrender period, for example, starting at 7% in the first year and decreasing by one percentage point each year. These charges are distinct from IRS penalties.

For non-qualified annuities, which are funded with after-tax dollars, a portion of the withdrawal may be considered a non-taxable return of premium, also known as basis recovery. Once all earnings have been withdrawn and taxed under the LIFO rule, subsequent withdrawals represent a return of the original principal contributions. This return of principal is not subject to income tax because the money was already taxed before being invested into the annuity.

Navigating Early Withdrawals and Exceptions

Withdrawing funds from an annuity before reaching age 59½ generally triggers an additional 10% early withdrawal penalty from the IRS. This age threshold is a significant benchmark, as withdrawals made after this age typically avoid the 10% penalty, though ordinary income tax on earnings still applies. However, several specific circumstances and structured withdrawal strategies can allow for penalty-free access to annuity funds before this age.

Exceptions to the 10% early withdrawal penalty include the death of the annuity owner, allowing beneficiaries to receive distributions penalty-free regardless of their age. Another exception applies if the annuity owner becomes permanently disabled, as defined by IRS guidelines. Documented proof of a severe and lasting physical or mental condition that prevents engaging in substantial gainful activity can qualify for this penalty waiver.

A planned strategy known as Substantially Equal Periodic Payments (SEPPs), or 72(t) distributions, allows individuals to take a series of equal payments from their annuity for a period of at least five years or until they reach age 59½, whichever is longer, without incurring the 10% penalty. The amount of these payments is calculated using IRS-approved methods, such as the annuitization method or the minimum distribution method, and must remain consistent for the specified period. Deviating from the established payment schedule can result in the retroactive application of the 10% penalty to all prior distributions.

Qualified Longevity Annuity Contracts (QLACs) offer another specific exception, allowing a portion of an individual’s retirement savings to be used to purchase an annuity that defers income payments to a very advanced age, such as 85. Funds invested in a QLAC are excluded from required minimum distribution (RMD) calculations until payments begin, thereby offering a way to delay distributions without penalty beyond traditional RMD ages. Additionally, limited exceptions for the 10% penalty may exist for certain qualified annuities when funds are used for unreimbursed medical expenses exceeding a certain percentage of adjusted gross income, higher education expenses, or for a first-time home purchase, though these exceptions are more commonly associated with qualified retirement plans like IRAs.