How to Close an Annuity: Steps and Considerations

An annuity is a financial contract purchased from an insurance company, designed to provide a steady stream of income, often during retirement. Individuals typically contribute a lump sum or a series of payments, which then grow on a tax-deferred basis until distributions begin. While annuities are long-term financial tools, owners may consider closing the contract, requiring an understanding of the process and implications.

Understanding Your Annuity Contract and Terms

Before taking any action, thoroughly review your specific annuity contract and recent statements. These documents contain the precise terms governing your agreement, including the type of annuity you own, which directly influences the closure process. Annuities can be broadly classified as fixed, variable, immediate, or deferred, each with distinct characteristics that affect potential withdrawal or surrender conditions.

Identify the surrender period in your contract, a timeframe during which penalties apply for early withdrawals or full closure. This period typically ranges from three to ten years, with six to eight years being common. If you are still within this period, the contract will detail the applicable surrender charges. These charges are usually a percentage of the amount withdrawn, starting higher in the initial years, often between 7% and 10%, and gradually decreasing annually until the surrender period concludes.

Many annuity contracts also include a “free withdrawal” provision, allowing access to a certain percentage of the account value, commonly up to 10% annually, without incurring surrender charges. Review the contract for any riders or special provisions, such as death benefits or living benefits, as these can affect the annuity’s value or closure terms. Locate the annuity provider’s contact information, including customer service numbers or online portals, for initiating inquiries or actions.

Many annuity contracts include a “free look” period, typically 10 to 30 days after contract delivery, during which you can cancel the annuity without incurring surrender charges. This period allows new owners to review the contract fully and decide if it aligns with their financial needs. If you are within this initial window, canceling the contract can be a straightforward process, resulting in a full refund of the premium paid.

Calculating the Financial Impact of Closure

Closing an annuity involves surrender charges and tax implications, requiring careful calculation. Once you identify the surrender charge schedule in your contract, you can estimate the dollar amount. For instance, if your contract specifies a 5% surrender charge on a $100,000 annuity value, the charge would be $5,000. This percentage applies to the amount withdrawn or surrendered, and you should account for any free withdrawal provisions that might reduce the taxable portion.

Beyond surrender charges, taxation of annuity withdrawals is a key consideration. Annuities are categorized as either “qualified” or “non-qualified.” Qualified annuities are funded with pre-tax dollars within retirement plans like 401(k)s or IRAs, meaning both contributions and earnings are taxed as ordinary income upon withdrawal. Non-qualified annuities are purchased with after-tax dollars, and only the earnings portion is subject to taxation.

For non-qualified annuities, the Internal Revenue Service (IRS) applies the “Last-In, First-Out” (LIFO) rule for withdrawals. This means earnings within the annuity are considered withdrawn first and are taxed as ordinary income before the original, after-tax principal contributions are returned. For example, if a non-qualified annuity with $50,000 in earnings and $100,000 in principal is partially surrendered for $60,000, the first $50,000 would be fully taxable as ordinary income, and the remaining $10,000 would be a tax-free return of principal.

Individuals under age 59½ may face an additional 10% early withdrawal penalty, imposed by the IRS on the taxable portion of the distribution. This penalty applies unless specific exceptions are met, such as distributions due to death or disability of the annuity owner. Other exceptions include distributions made as a series of substantially equal periodic payments (SEPP) over the owner’s life expectancy, or those used for certain unreimbursed medical expenses. State income taxes may also apply to annuity withdrawals, depending on your state of residence.

After accounting for surrender charges and estimated tax liabilities, calculate the net proceeds you would receive from closing your annuity. This calculation helps determine if full closure aligns with your financial needs and long-term objectives. Consulting with a tax professional can help ensure accuracy in these calculations.

Steps to Close Your Annuity

After reviewing your contract and assessing financial implications, begin the procedural steps to close your annuity. First, contact your annuity provider directly via their customer service phone line, online portal, or written request. Be prepared to provide identifying information, such as your policy number and personal details, to verify your identity.

Request the necessary surrender or withdrawal forms. These forms are specific to each provider and are required to initiate the closure process. The provider’s representative can guide you on how to obtain these documents, which may be available for download from their website or sent by mail.

Carefully complete all sections of the surrender forms. Accurately fill out each field as instructed, including your annuity details and desired payout method. Some forms may require a notarized signature; check for such requirements. You will also need to specify how you wish to receive the funds, whether by direct deposit or check.

After completing and, if necessary, notarizing the forms, submit them to your annuity provider through their specified channels. Common submission methods include mail, online upload to a secure portal, or fax. Using certified mail with a return receipt is advisable for mailed documents, as it provides proof of delivery.

Following submission, the annuity provider will begin processing your request. The typical timeline for processing a full surrender can vary, ranging from a few days to several weeks or months, depending on your annuity’s complexity and the provider’s internal procedures. The company will usually confirm receipt and provide an estimated timeframe for completion and fund disbursement. The annuity company will issue a tax form, such as Form 1099-R, reporting the distribution to you and the IRS for the tax year of closure.

Exploring Alternatives to Full Closure

Rather than fully closing an annuity, several alternative strategies can provide access to funds or adjust the contract to better suit evolving financial goals, potentially mitigating some costs associated with full surrender.

Partial Withdrawals

One common alternative is to take partial withdrawals. Many annuity contracts permit owners to withdraw a portion of their annuity’s value, often up to 10% annually, without incurring surrender charges. While this can provide liquidity, any earnings withdrawn would still be subject to ordinary income tax and potentially the 10% early withdrawal penalty if the owner is under age 59½.

Annuitization

Another option is annuitization, which involves converting the annuity’s accumulated value into a guaranteed stream of regular income payments. This can be structured to last for a set period or for the remainder of the owner’s life. Once an annuity is annuitized, the principal generally cannot be accessed as a lump sum, and the contract cannot typically be canceled.

1035 Exchange

A third alternative involves a 1035 exchange, which allows for the tax-free transfer of funds from one annuity contract to another. This provision, outlined in Internal Revenue Code Section 1035, enables owners to move their annuity funds to a new contract, perhaps one with more favorable terms or different investment options, without immediately recognizing taxable gains. The exchange must involve a direct transfer between insurance companies, and the owner and annuitant generally must remain the same. While the exchange itself is tax-free, the new annuity contract will typically come with its own surrender period, effectively restarting the clock on potential surrender charges if future withdrawals are needed.