How to Get Out of an Annuity and Access Your Funds

An annuity is a contractual agreement with an insurance company, designed to provide a steady stream of payments, often for retirement. While annuities offer financial security and tax-deferred growth, circumstances can shift, leading individuals to reconsider their initial plans. Accessing funds, whether fully exiting the contract or making partial withdrawals, involves navigating specific terms and potential financial implications. This article explores common methods for managing annuity investments differently.

Understanding Your Annuity Contract Details

Reviewing your annuity contract details is essential before accessing funds. Annuities come in various forms, such as fixed, variable, and indexed, each with distinct features. A fixed annuity offers guaranteed interest rates, a variable annuity’s value fluctuates with investment performance, and an indexed annuity links returns to a market index.

Locate your annuity’s accumulated value, which is the total amount in the account. This may differ from the cash surrender value, the amount received after fees or penalties. Your contract details the surrender charge schedule, outlining penalties for early withdrawals. These charges often start higher, for example, around 7% in initial years, and gradually decrease over time.

A free look period, usually 10 to 30 days after receiving the contract, allows penalty-free cancellation. This period is important for new purchasers to review their decision, but it generally does not apply to long-held annuities. Annuity contracts also include death benefit provisions, explaining how funds are distributed to beneficiaries upon the owner’s passing. Annuitization options describe how the accumulated lump sum can be converted into a stream of periodic payments, which typically prevents immediate access to the principal.

Understanding your tax basis is important, as it distinguishes between after-tax contributions and tax-deferred gains. This distinction determines the taxable portion of any withdrawal. Consult your contract or contact the annuity provider or a financial advisor for clarification.

Pathways to Full Annuity Exit

Fully terminating an annuity contract involves distinct processes, each with specific requirements and financial implications. These methods allow for the complete liquidation or transfer of the annuity’s value.

Surrendering the annuity

Surrendering the annuity is the most direct way to terminate the contract and receive its cash value. This involves contacting the insurance company and submitting documentation. Applicable surrender charges, outlined in your contract, will be deducted from the accumulated value. For instance, a 7% surrender charge on a $100,000 cash value would result in a $7,000 deduction.

Gains within non-qualified annuities are taxed as ordinary income in the year of surrender. If you are under age 59½, an additional 10% federal early withdrawal penalty generally applies to the taxable portion, in addition to regular income taxes.

Executing a 1035 exchange

A 1035 exchange allows tax-free transfer of funds from one annuity to another, or from a life insurance policy to an annuity. This enables switching to a new annuity with better features or lower fees without triggering immediate income taxes on gains. To qualify, the transfer must be direct between insurance companies; you cannot receive the funds yourself. While tax-deferred, the new annuity will typically have its own new surrender charge period.

Selling your annuity on the secondary market

Selling your annuity on the secondary market is an option, especially for structured settlements or immediate annuities, exchanging future payments for a lump sum. This involves selling payment rights to a third-party company. The process usually entails obtaining a quote, legal review, and often requires court approval for structured settlements to ensure seller protection.

While providing immediate liquidity, the lump sum is discounted compared to total future payments, reflecting the time value of money and buyer profit. Fees are involved, and secondary market annuities are not regulated as traditional annuities, so they may not carry the same state guaranty fund protections.

Utilizing the free look period

The free look period, usually 10 to 30 days after receiving your contract, allows you to cancel the annuity for a full premium refund without penalty. To cancel, notify the annuity company and submit documentation within this timeframe. This option is relevant only for very recent annuity purchases, as it is a consumer protection mechanism designed to allow new buyers to reconsider their decision.

Accessing Annuity Funds Partially

For individuals needing partial access to funds without terminating their annuity, these methods offer flexibility while maintaining the core contract. They allow withdrawals or loans against the annuity’s value, with specific rules and financial considerations.

Partial withdrawals

Partial withdrawals allow you to take out a portion of your annuity’s accumulated value. Most contracts include a “free withdrawal” allowance, often up to 10% of the account value annually, without surrender charges. Exceeding this triggers charges on the excess.

For non-qualified annuities, withdrawals are taxed on a Last-In, First-Out (LIFO) basis, meaning the earnings are considered to be withdrawn first and are subject to ordinary income tax. Once all earnings are withdrawn, subsequent withdrawals of your original after-tax contributions (basis) are not taxed. Partial withdrawals reduce the annuity’s overall value, diminishing future growth potential and death benefits.

Annuity loans

Annuity loans may be available, particularly with certain variable annuities or those in qualified retirement plans. Not all contracts offer a loan provision, so review your specific contract. If available, loan terms include an interest rate and repayment schedule.

Borrowing can reduce cash value for investment growth and impact guaranteed benefits. If not repaid, the outstanding amount could become taxable, and if in a qualified plan, it could be a taxable distribution subject to the 10% early withdrawal penalty if under age 59½.