Can You Withdraw Money From an Annuity?
Annuities are an insurance contract that you can purchase with a lump sum premium, or by paying small premiums over time. The rules governing how and when you can withdraw your money vary depending on the annuity policy.
Can you withdraw some or all of your money from an annuity early? In some cases, yes, and there are some legitimate reasons why you might choose to do so. However, many annuities have restrictions on withdrawals, and an early withdrawal could impact future income from the annuity, and trigger penalties and taxes. It depends on the type of annuity you own, as well as the regulations in your state.
Key Points
• An annuity is an insurance contract that you can purchase by making premium payments, and designed to provide a stream of income in retirement.
• It’s possible to withdraw funds early from an annuity, although you’ll likely face a 10% if you’re under 59 ½.
• Annuities typically come with a surrender period, during which withdrawals are not allowed. Any money withdrawn during the surrender period could incur a 7% penalty, on top of the 10% early withdrawal if you’re not yet 59 ½.
• Annuities are complex and it’s important to understand the terms of the contract before committing to an annuity purchase.
Understanding Annuities and Annuity Withdrawals
An annuity is a type of insurance contract that’s designed to provide a predictable stream of income in retirement. Typically, the owner would purchase an annuity with a lump sum premium, and take payments from the annuity according to the agreed-upon terms.
Generally, the annuity company agrees to provide a stream of income at a future date (or immediately), for a specific period of time or until the death of the annuity holder, also called the annuitant. In some cases, there may be a death benefit paid to a beneficiary, such as a surviving spouse.
Annuities can be a useful part of your retirement plan, but because they are insurance products, not securities, the terms of an annuity may not be familiar to many investors.
Recommended: Annuity Definition
The Complexity of Annuities
Unlike putting money into an IRA or 401(k), which is fairly straightforward and governed by a set of rules determined by government laws and agencies, buying an annuity is vastly more complicated — and this impacts how and when you can withdraw money from an annuity.
The rules governing these products vary from company to company, and from policy to policy. For example, some annuities are considered “fixed annuities,” because they earn a fixed rate of interest. Some are “variable annuities,” because the funds in the annuity may fluctuate because they’re invested in the market.
Annuity holders can tailor their annuities to some degree, by purchasing riders, or special terms that provide for inflation adjustments, lifetime payments, survivor benefits, and other factors. SoFi does not sell annuity products.
How an Annuity Works: The Basics
When purchasing an annuity, you (the account holder) might pay a lump sum premium, or make a series of premium payments over time to build up the value of the policy.
Sometimes, the funds within an IRA or 401(k) can be used to purchase an annuity or pay annuity premiums, when the annuity is held within one of those qualified retirement accounts.
After this accumulation phase, the company begins making regular income payments. This is known as annuitization. The annuity holder can decide, as part of the annuity contract, exactly when payments will begin and how long the distribution phase will last.
For example, you might structure your annuity payments over 10 years, or you might set up guaranteed payments for the rest of your life. The annuity terms and fees depend on the structure of the distribution phase.
The Surrender Period
Money paid into the annuity typically can’t be withdrawn for a certain amount of time without owing a stiff penalty; this is called the surrender period and those terms, and any exceptions, are set by your insurance company.
Again, annuities generally have different rules about early withdrawals, but during the surrender period taking a withdrawal could incur a 7% penalty, in addition to a potential 10% penalty if you’re under 59 ½.
Your choice of annuity will influence your withdrawal options.
Types of Annuities
There are many types of annuities you might choose from to support your financial goals in retirement.
Fixed and Variable Annuities
A primary consideration when selecting an annuity is whether your money earns a steady rate of interest, which is the hallmark of a fixed annuity, or whether it’s invested in underlying assets and tied to market performance to some degree (e.g., via mutual funds or index funds). This would create a variable income stream.
• Fixed annuities offer a guaranteed minimum income benefit (or GMIB) for a set period.
• Variable annuities generate returns based on the performance of underlying investments and the rate of return is not guaranteed.
Within these two branches, fixed and variable annuities, there are other categories.
Other Annuity Categories
• Immediate. When you buy an immediate annuity, you fund it with a lump sum and payouts to you can begin in as little as one year.
• Deferred. Deferred-income annuities can be funded with a lump sum or multiple smaller payments, and payouts to you can begin several years after the purchase.
• Indexed. Indexed annuities generate a rate of return that’s based on the performance of an underlying stock market index, such as the S&P 500.
It’s not unusual to see these terms combined. For example, you might purchase an immediate fixed annuity or deferred variable annuity, based on your needs.
Withdrawal Options for Annuities
The two main considerations here are: First, whether you’re over the age of 59 ½ and second whether you’re still within the surrender period. For example, if you’re younger than 59 ½, and thus taking an early withdrawal, that would trigger a 10% penalty — similar to taking an early withdrawal from an IRA.
The penalty would be steeper if the early withdrawal was also within the surrender period.
If You’re Not Taking an Early Withdrawal
If you’re over 59 ½ and past the surrender period, you would be able to take a withdrawal without a penalty, but you would owe ordinary income tax on the earnings portion of the withdrawal.
If your annuity is held within a 401(k) or tax-deferred IRA account, you would owe tax on the full amount of the withdrawal.
Bear in mind that state regulations may also come into play.
• Partial surrender. If your annuity has not yet been annuitized, meaning your regular payments have not begun, you may be able to make a partial surrender of its value to withdraw cash.
• Full surrender. You could opt to make a full surrender instead if you no longer need the annuity. A surrender fee may apply to partial or full surrenders, and you typically have only a few years after purchasing the annuity to exercise either option.
• Periodic payments. You might have the option to take recurring payments from your annuity, separate from the amounts you’re entitled to receive once the contract has been annuitized.
A 1035 exchange is another option if you’d like to have an annuity but aren’t happy with your current one
Early Withdrawal Penalties
The IRS imposes a 10% early withdrawal penalty when you take money from tax-advantaged accounts before age 59 ½. That rule extends to annuities held within an IRA, unless you qualify for an exception.
For example, you could avoid the penalty if you’re making an early withdrawal because you:
• Become totally and permanently disabled
• Plan to use the money to fund a birth or adoption, higher education expenses, or the purchase of a first home
• Are subject to an IRS levy
• Have unreimbursed medical expenses that exceed 7.5% of your adjusted gross income
If you’re subject to a 10% early withdrawal penalty on top of income tax, on top of surrender charges that could quickly make an early withdrawal from an annuity expensive.
Required Minimum Distributions (RMDs)
Required minimum distributions or RMDs are amounts you’re required to withdraw from certain retirement accounts, typically beginning at age 73. The amount you’re expected to withdraw is based on your account value, age, and life expectancy, as established by the IRS.
Qualified accounts, including qualified annuities, are subject to these rules under the Internal Revenue Code. If you have a qualified annuity and do not begin taking RMDs on time, you could be hit with a penalty. The penalty is equal to 25% of the amount you were required to withdraw.
IRA annuity withdrawal rules allow you to skip RMDs if you have a Roth account. However, if someone inherits a Roth IRA annuity from you, they would be subject to RMDs.
Factors to Consider Before Withdrawing
Rather than asking, Can I withdraw all my money from an annuity? the better question may be whether you should tap your annuity early. There are advantages and disadvantages to weigh before making a move.
Impacts on Lifetime Income Stream
If you plan to withdraw money from an annuity early, ask yourself what that might mean later if you’re relying on that income for retirement. Taking money from your annuity now can affect its growth, potentially leaving you with smaller payments later on.
You’d have to consider how smaller payments might affect your broader retirement picture. For example, if your payouts would shrink from $2,000 per month to $1,200 per month, would you be able to make up the gap with other retirement savings or Social Security benefits?
If not, then you may need to rethink your early withdrawal plans. This retirement planning guide offers more tips on how to plan your income strategy.
You can also use a retirement calculator to estimate what you’ll need.
Surrender Charges and Fees
Annuity companies may let you take money from an annuity early but they don’t allow you to do it for free. You may have to pay a surrender fee, which can eat into your withdrawal amount. For example, if you’re taking out $20,000 and the surrender fee is 7%, you’re handing over $1,400 to the annuity company.
Surrender charges may decrease as time goes on, so you might save a little money if you can wait a few years to make a withdrawal. If you’re not thrilled about paying the fees, however, you might consider other ways to access cash.
Alternatives to Withdrawals From an Annuity
If you no longer need your annuity, you could sell some or all of the payments owed to you for cash. The amount you can get will depend on your contract’s current value and the company you’re working with. You’ll need to find a reputable annuity buyer, and you may want to compare offers to find the best deal.
If you want to keep your annuity, you might consider other ways to borrow the cash that you need. Your options may include:
• Selling or cashing out a cash-value life insurance policy you own
• Taking out a home equity loan or line of credit
• Taking an early withdrawal from an IRA
• Getting a personal loan or line of credit
Some of these options have more pros and cons than others. Borrowing from your 401(k), for example, can shrink your retirement nest egg and potentially trigger tax penalties if you don’t pay it back on time. Weighing all the possibilities can help you decide on which path to take.
Strategies for Withdrawing from an Annuity
If you’re interested in how to withdraw money from an annuity while minimizing penalties and fees, there are a few things to keep in mind. These tips can help you figure out the best way to withdraw from your annuity.
Annuity Withdrawal Calculators
Annuity withdrawal calculators can help you estimate what you can get from your annuity, should you decide to withdraw early. They can also tell you how much you might owe in taxes and penalties for an early withdrawal.
Seeing the numbers can put the true cost of an early withdrawal in perspective. You might decide that it makes more sense to choose another option if what you’d pay to make the withdrawal outweighs what you’d gain.
Tax Planning and Optimization
The last thing you want is to end up with a surprise tax bill following an early annuity withdrawal. If you know how much you plan to withdraw, consider how that’s going to affect you tax-wise. Specifically, consider whether it would:
• Push you into a higher tax bracket for that tax year
• Trigger a 10% early withdrawal penalty, based on your age
If a withdrawal would bump you into a higher tax bracket, even temporarily, you may need to think about how you could offset it. For example, could you make a tax-deductible contribution to an IRA or a donation to an eligible charity? Or, would it be possible to wait and take the withdrawal next year, if you expect your income to be lower then?
Thinking ahead can help you avoid a situation where you’re stuck with a tax bill you can’t afford.
Consulting a Financial Advisor
Annuities can be complicated products and if you find it challenging to make sense of your contract’s terms or have questions about the tax consequences, it’s probably in your best interest to talk to a financial advisor.
A professional advisor can walk you through your withdrawal options, based on the terms of your annuity contract, and guide you through the potential tax impacts. And if you decide that an annuity withdrawal isn’t right for you, an advisor can suggest other possibilities for getting the cash you need.
The Takeaway
How do you withdraw money from an annuity? With careful thought, if you intend to minimize what you pay in taxes and fees.
If you have an annuity, or you’re thinking of adding one to your financial plan, it’s important to understand what you’re getting and what you might pay if you decide to take cash from your contract early. After all, an annuity is one part of your overall retirement plan — which may include an IRA, a 401(k) or other accounts. Whatever you decide should make sense in light of your other investments.
Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
FAQ
What is the penalty for withdrawing from an annuity early?
The IRS imposes a 10% early withdrawal penalty when you withdraw money from an annuity before age 59 ½. The withdrawal is also subject to ordinary income tax and you may be required to pay a surrender charge to the annuity company if the withdrawal is during the surrender period.
Can you withdraw the entire annuity balance at once?
As long as your annuity contract permits it you can make a full or partial withdrawal. A full surrender would effectively cancel your contract, while a partial surrender might still allow you to receive annuitized payments later.
How are annuity withdrawals reported for tax purposes?
Withdrawals from qualified annuities are subject to ordinary income tax on the entire withdrawal amount. Nonqualified annuities are subject to income tax only on the earnings withdrawn. Both types of annuities are subject to a 10% early withdrawal penalty when you take money out before age 59 ½, unless an exception applies.
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