Surrender Charges
Surrender charges protect the insurance company like guarantee of principal protects the owner. Surrender penalties with some annuities disappear over a 5-year to 15-year period of time. With other annuities, surrender charges can reappear at the end of a surrender charge after a penalty — free surrender period of, for example, 30 days. Most of the time, the penalties are imposed on principal and interest (excluding the 10% free partial withdrawal). One example of penalties might be 7%, if the annuity is surrendered during year one. Penalties could then decrease 1% each year (-6%-5%-4%-3%-2%-1%-0%).

Example / Surrender Charges

Bill and Mary, ages 60 and 61 respectively, have about $300,000 in total savings in the bank in Certificates of Deposit, money market accounts, and in passbook savings.

Since they want to accumulate money faster, they decided to place all of their money in a fixed annuity that has a 10% free annual withdrawal and a surrender charge of 15% decreasing 1% each year.

In year six, when the annuity has a value of $400,000, an emergency arises and Bill and Mary need $100,000. What are the surrender charges? Since their annuity has a free 10% annual withdrawal, $40,000 can be withdrawn without a surrender charge penalty (10% of $400,000). However, the difference, $60,000, will be subject to a surrender charge. In this example, the surrender charge in year six is 10%. In other words, the surrender charge is $6,000 (10% of $60,000, the surrender charge).

What can be learned from this example? First, since interest is withdrawn first, the $100,000 withdrawn would be subject to ordinary income taxes since the $300,000 had grown to $400,000 and the $100,000 was all interest. Since Bill and Mary are older than 59.5, there will not be a 10% federal excise tax penalty. However, we can learn two other important things from this fictional story about Bill and Mary. First of all, few people, especially a senior, should place all or almost all of their dollars in an annuity or any financial product for that matter. Secondly, a double digit surrender charge and a double digit surrender charge period for a senior who had placed too much of their money in an annuity might not have been the preferred thing to do. Perhaps if they had placed only $100,000 or $200,000 in an annuity and kept the balance in a money market or passbook savings accounts, the money they needed for an emergency could be easily found in those two other banking instruments. And, the end result is that Bill and Mary could have avoided $6,000 in surrender charges.

What can also be learned from this example? Diversify and do not put all of your dollars in any one given product. A senior should consider a surrender charge period appreciably shorter than the one used in this example.

This story is fictional and does not portray any individual(s) or company(ies) nor any anticipated performance of any specific product.