When Can You Take Money Out of an Annuity?

An annuity is a financial contract between an individual and an insurance company, where the company agrees to make payments in exchange for premiums. Annuities are primarily long-term savings vehicles, useful for generating retirement income. Understanding withdrawal rules is important for anyone considering them as part of a financial plan.

Standard Annuity Withdrawal Timing

Penalty-free withdrawals from an annuity can begin when the annuitant reaches age 59½. This age aligns with federal tax guidelines for many retirement accounts. Funds withdrawn before this age may be subject to additional taxes and penalties.

The primary purpose of an annuity is to convert a lump sum into a steady income stream through “annuitization.” During annuitization, the annuity’s value transforms into regular payments for a specified period (e.g., 10 or 20 years) or the annuitant’s life. This provides a predictable income flow, reducing the concern of outliving savings. Some annuity contracts also permit partial withdrawals or the complete surrender of the contract after the annuitant reaches age 59½ without incurring company-imposed penalties.

Early Withdrawal Penalties

Early annuity withdrawals can lead to significant financial consequences. One such consequence is a 10% additional tax imposed by the Internal Revenue Service (IRS) on the taxable portion of the withdrawal. This federal penalty applies on top of regular income tax, increasing the tax burden. The IRS assumes that earnings are withdrawn first from non-qualified annuities, making these early withdrawals largely taxable and subject to the penalty.

In addition to the IRS penalty, insurance companies often impose “surrender charges” or “surrender fees” for early withdrawals. These charges are a percentage of the amount withdrawn, discouraging short-term use of a long-term investment. Surrender charges decrease over a defined period, typically three to 10 years from inception. For instance, a contract might have an 8% surrender charge in the first year, which then gradually declines to zero by the end of the surrender period. Some annuities allow annual withdrawals of up to 10% of the accumulated value without these charges.

Circumstances Allowing Penalty-Free Early Access

While early withdrawals from annuities incur a 10% IRS penalty, specific exceptions allow access to funds without this additional tax. These exceptions are outlined under IRS Section 72(t) and include:

Distributions made to a beneficiary after the annuitant’s death.
Withdrawals due to the annuitant becoming totally and permanently disabled.
Withdrawals as part of a series of substantially equal periodic payments (SEPPs), calculated based on life expectancy and continuing for at least five years or until age 59½, whichever is longer. Modifying the payment schedule before meeting these conditions may retroactively apply the 10% penalty.
Withdrawals for unreimbursed medical expenses exceeding a certain percentage of adjusted gross income.
Funds for qualified higher education expenses (e.g., tuition, fees, books) for the annuitant, spouse, children, or grandchildren.
Withdrawals up to $10,000 for a first-time home purchase.
Payments received when the annuity contract is annuitized into a stream of regular income, regardless of age.

Tax Implications of Withdrawals

Annuity withdrawals are subject to taxation as ordinary income. The specific tax treatment depends on whether the annuity is considered “qualified” or “non-qualified.”

Non-qualified annuities are funded with after-tax dollars, meaning the contributions themselves have already been taxed. For these annuities, the IRS applies a “last-in, first-out” (LIFO) rule for withdrawals. This rule dictates that earnings or investment gains are considered to be withdrawn first and are fully taxable as ordinary income until all accumulated earnings are depleted. Once the earnings portion has been exhausted, any subsequent withdrawals are treated as a return of the original principal, which is not taxed since contributions were made with after-tax money.

In contrast, qualified annuities are funded with pre-tax dollars, often through retirement accounts (e.g., IRAs, 401(k)s). Since neither contributions nor earnings were previously taxed, all withdrawals from a qualified annuity are taxed as ordinary income. Every dollar received, whether contributions or growth, is subject to income tax. Distinguish this income tax from the 10% early withdrawal penalty; the penalty is an additional charge for accessing funds before age 59½, while income tax applies to the taxable portion regardless of age.

Initiating an Annuity Withdrawal

To begin the process of withdrawing funds from an annuity, the policyholder must gather necessary information. This typically includes the annuity contract number, personal identification details, and the precise amount intended for withdrawal. If the withdrawal is for a specific purpose that may qualify for a penalty exception (e.g., medical expenses or a first-time home purchase), any relevant supporting documentation should also be prepared. Bank account details, including routing and account numbers, are needed for direct deposit.

The next step involves contacting the annuity provider. This can usually be done through their customer service phone line, official website, or by mail. The provider will then supply a specific withdrawal request form that must be accurately completed.

This form will require the previously gathered information and may ask for the reason for the withdrawal. After the form is filled out and any required supporting documents are attached, it must be submitted to the annuity company via their designated channels (mail, fax, or an online portal). Following submission, the provider will process the request, which may take several business days, and will typically provide confirmation once the transaction is complete.