Annuities can be a great investment for retirement savings and estate planning, but they are often passed over due to the expenses and long-term contracts associated with this type of investment. If money is withdrawn from an annuity before the contract specifies, hefty penalties are assessed. Also, tax penalties may be involved when funds are withdrawn from an annuity. The amount of the penalty depends on the investor’s age at the time of withdrawal, how long the investment has been held and the circumstances for making the withdrawal.
Surrender Charges
Annuity contracts are issued by insurance companies for a specified investment term, typically from four to seven years. For each year the investment is held, the penalty for early withdrawal changes, getting lower the longer the annuity is held. This is called a surrender schedule. It is not uncommon for an early withdrawal penalty made in the first few years of owning an annuity to exceed 5%.
Tax Penalties
In addition to penalties assessed by the insurance company, early withdrawals may also trigger an Internal Revenue Service (IRS) penalty. Annuities are considered a retirement product by the IRS, regardless of whether the contract is held in an Individual Retirement Account (IRA). Even non-qualified annuities require the owner reach the age of 59.5 before taking penalty-free distributions.
Disability and Long-term Care Withdrawals
Fortunately, as retirement accounts, annuities allow for early withdrawal with no penalty in the event the annuitant becomes disabled. Additionally, some contracts offer a benefit for taking penalty-free withdrawals to pay for long-term care expenses. Many contracts also let the owner withdraw up to 10% of the contract value or premium each year, as defined in the contract, penalty-free.