What Is the Nonforfeiture Value of an Annuity Before Annuitization?

Annuities serve as long-term financial products designed to provide a steady income stream during retirement. While structured for future payouts, circumstances can arise where access to accumulated funds becomes necessary before income payments commence. Understanding the value accessible prior to the payout phase is important. This article explores the nonforfeiture value, a concept related to early access.

Understanding Annuity Basics

An annuity represents a contract between an individual and an insurance company, where the individual makes payments in exchange for future income. This product operates in two phases. The “accumulation phase” is when money is contributed and grows on a tax-deferred basis, based on fixed interest rates or market-linked performance.

The “payout phase,” also called the “annuitization phase,” is when the accumulated value converts into a stream of regular income payments. Annuitization marks the transition from saving to receiving disbursements. This article focuses on the accumulation phase, examining the value available before annuitization begins.

The Concept of Nonforfeiture Value

The nonforfeiture value represents a minimum guaranteed amount an annuity owner is entitled to receive if they surrender their contract or cease making premium payments before the annuitization phase. This provision protects policyholders from forfeiting their entire investment. Regulatory frameworks, often at the state level, mandate that annuity contracts include these nonforfeiture benefits. It prevents a complete loss of funds should the annuity owner’s financial situation change or if they need to access their money prematurely. This value is distinct from the total premiums paid or the overall account value, as it accounts for specific adjustments and charges outlined in the contract.

Components and Calculation of Nonforfeiture Value

The nonforfeiture value during its accumulation phase is influenced by several factors. Premiums paid form the foundation, representing the initial and subsequent contributions made by the annuity owner.

These payments are the principal upon which the annuity’s value is built. Interest or growth credited to the annuity also adds to the nonforfeiture value. This growth can stem from fixed interest rates, market performance for variable annuities, or index performance for indexed annuities. As the annuity accumulates earnings, this increases the potential nonforfeiture amount.

However, various fees and charges reduce the value. These commonly include administrative fees (around 0.3% of the annuity’s value annually or a flat fee ranging from $50 to $100) for record-keeping and account management. For variable annuities, mortality and expense (M&E) charges (typically 0.25% to 1.75% annually) compensate the insurer for guaranteed benefits like death benefits. Optional riders, such as guaranteed income benefits, also incur fees (often 0.25% to 1.5% of the contract value per year).

Surrender charges are significant factors that impact the net amount received upon early access, but it is important to understand how they relate to the nonforfeiture value itself. These charges are penalties for withdrawing funds or surrendering the contract before the end of a specified period, typically ranging from three to ten years after purchase. While the nonforfeiture value is the amount available before these charges are applied to a specific withdrawal action, the potential for these charges influences the effective liquidity. Surrender charges are often a percentage of the amount withdrawn, starting as high as 7% to 10% in the first year and gradually decreasing over the surrender charge period.

Additionally, some fixed or indexed annuities may include Market Value Adjustments (MVAs). MVAs can either increase or decrease the nonforfeiture value at the time of withdrawal, depending on changes in interest rates since the contract’s inception. If prevailing interest rates are higher than when the annuity was purchased, the MVA may reduce the value, while lower rates could increase it.

Accessing and Implications of Nonforfeiture Value

An annuity owner can access their nonforfeiture value through several methods, each carrying specific financial consequences. One common approach is a full surrender, where the entire annuity contract is terminated. The owner receives the nonforfeiture value, but this amount is subject to the deduction of any applicable surrender charges and potential taxation.

Another method is making partial withdrawals, which allows the owner to take out a portion of the accumulated value. Many contracts permit penalty-free withdrawals of a certain percentage, often up to 10% of the account value, annually. However, withdrawals exceeding this allowance or those made within the surrender charge period will incur the specified surrender charges, which are deducted from the amount received.

Accessing the nonforfeiture value has financial implications beyond surrender charges. Any gains realized from the annuity are taxed as ordinary income. If the annuity owner is under age 59½ at the time of withdrawal, a 10% federal early withdrawal penalty applies to the taxable portion, as per Internal Revenue Code Section 72, unless a specific exception is met.

Taking funds from the nonforfeiture value also means forfeiting future benefits the annuity could have provided. This includes the loss of potential tax-deferred growth, any guaranteed income streams that would have been available upon annuitization, and the benefits of any riders, such as enhanced death benefits or guaranteed minimum withdrawal benefits. The decision to access the nonforfeiture value should consider these long-term impacts on one’s financial plan.