(Nasdaq) - Even though we’re living in an increasingly cashless world, there are still times when you need to withdraw cash. Case in point, my local coffee shop is cash-only. That means whenever I’ve craving one of their delicious cappuccinos, I have to visit the ATM first.
Unfortunately, when it comes to withdrawing funds from your annuity, it’s not as simple as accessing an ATM and taking cash out of your checking account.
Why is this the case? Annuities were designed to provide regular income during retirement. As such, the IRS imposed financial penalties for owners who withdrew more than allowed.
So, before withdrawing money from your annuity, consider the consequences for the federal government and for the issuing insurer. For instance, selling a portion of your annuity payments might be a better alternative if the consequences outweigh the benefits.
Despite this, you can withdraw money from your annuity before retirement without triggering penalties. Here, we’ll explain how you can withdraw money from your annuity. Also, we’ll share how to cash out an annuity without paying a substantial penalty.
Getting You Up to Speed on Annuities
Let’s take a quick moment to review what an annuity is before we get to the rules about taking money out. An annuity is like a self-funded pension. In order to fund an annuity, you must make a deposit with a life insurance company. The payment can either be in a lump sum or in monthly installments.
With annuities, the risk is transferred from the owner, or annuitant, to the insurance company/annuity company. By charging a premium, the company offering the annuity assumes the risk on behalf of the owner. Depending on the annuity type, premiums can be paid in one or several installments. The payment of premiums occurs during the accumulation phase.
Annuities are popular for their ability to protect principals, provide lifetime income, and plan for legacy. If you break any contractual obligations, you’ll be subject to hefty penalties due to the fact that you’re locked into a contract. As a result, annuities are not as accessible as savings accounts.
The different types of annuities.
Annuities come in a variety of types, as mentioned above. Every annuity type offers different features based on a person’s financial situation. Depending on the type of annuity you have, you will withdraw money differently.
Listed below are some of the different types of annuities and how you’ll receive your payouts:
- An immediate annuity pays you back right away after you purchase it. Most often, they are suitable for people who are already retired or very close to retiring.
- In a deferred annuity, you earn interest over time before receiving a payout. During the term of your annuity, interest accumulates. There are several options when the term ends, including transferring to a new guaranteed term, annuitizing, or cashing out.
You can also choose how your money will grow with annuities:
- In fixed annuities, the interest rate is guaranteed to be at least a certain level. During the selected term, you will know exactly how much your account value will grow. An annuity with a fixed rate of return is the simplest and safest type. For example, a Due Fixed Annuity comes with a 3% guaranteed interest rate on your money.
- A variable annuity pays a variable interest rate based on the performance of the stock market. Fixed annuities are riskier than mutual funds, which are usually invested in mutual funds. It’s impossible to know whether your variable annuity will earn money since the market is unpredictable. There is even a possibility that it will lose money.
- A fixed-indexed annuity combines the benefits of both fixed and variable annuities. Generally, they pay a variable interest rate based on the performance of the index, as well as a fixed interest rate based on the performance of the index. You won’t lose any of your premiums, but you might not gain anything as well.
Which Types Of Annuities Allow Withdrawals?
Those who need regular liquidity can benefit from a deferred annuity since they are able to withdraw money from their accounts regularly. Additionally, annuity owners can withdraw their money as needed with deferred annuities, which can be paid monthly, quarterly, or annually.
As a result of their flexible withdrawal options, deferred annuities also allow annuity owners to alter withdrawals to fit their circumstances. Annuity owners can elect, for instance, to receive a lump sum payment at the end of the deferral period or to receive payments over a longer period of time.
A deferred annuity can take the form of a fixed annuity, a variable annuity, a fixed-indexed annuity, or a long-term care annuity.
Which Types Of Annuities Do Not Allow Withdrawals?
Despite providing a guaranteed income stream for life, immediate annuities cannot be withdrawn for regular liquidity purposes. Similarly, annuitized payments cannot be withdrawn. As a result, you cannot stop or change the number of payments you receive from an immediate annuity once you start receiving them. An immediate annuity is therefore not a wise choice if you need money sooner than expected.
Those contracts that do not allow withdrawals of annuities:
- Immediate Annuities
- Deferred Income Annuities
- QLAC
- Medicaid Annuities
- Annuitized Contracts
Considerations for Taking Early Withdrawals
A withdrawal from your annuity before retirement could be necessary (or desired) for a number of reasons. An unexpected expense, a job loss, or a medical emergency are the most common reasons for needing cash immediately. It’s also possible that you might choose to invest some money from your annuity elsewhere instead.
Regardless of the reason, it’s important to carefully consider the consequences of withdrawing from an annuity. If you’re thinking about making an early withdrawal, here are a few questions to ask yourself.
Is the annuity surrender charge still in effect?
An annuity surrender charge period tells you how long you have to keep your money in the annuity to avoid penalties. Surrender charge periods vary in length. However, it typically lasts between six and ten years. Typically, surrender charges are based on the amount withdrawn.
Typically, surrender charges start high in the first year and go down each year by a specific percentage. It is common for surrender charge periods to be “rolling.” In other words, each contribution to the annuity will have a separate surrender charge period.
A surrender charge of 7% may apply in year one, for example. Surrender charges decrease by 1% each year until after the seventh year when they are eliminated.
In short, prior to withdrawing from your annuity, ensure you are aware of the surrender charge period.
Surrender period withdrawals.
A surrender charge is included in annuity contracts to compensate the insurance company for the loss if you withdraw before your principal can earn interest. As annuity contracts mature and earn interest for the insurer, the surrender charge typically decreases. Again, upon expiration of the surrender period, there is no surrender charge.
Annuity owners are also discouraged from using deferred annuities as short-term investments for quick cash, according to the Insurance Information Institute.
It is common for insurance companies to let annuity owners withdraw up to 10% of the account value without imposing surrender charges. It is possible, however, that you will still have to pay a penalty if you withdraw more than your contract allows.
In certain annuity contracts, surrender charges are waived for special circumstances, such as confinement in a nursing home or terminal illness.
Do you know what the tax implications are?
The criteria for annuities aren’t limited to insurance companies.
The Internal Revenue Service uses its own criteria to determine how these products should be used and taxed, which is different from the criteria set forth by insurance companies.
As far as the insurer is concerned, you may withdraw money at your leisure. However, if you are under 59 ½, you will have to pay a 10% penalty to the IRS.
According to IRS Publication 575, “Most distributions (both periodic and nonperiodic) from qualified retirement plans and nonqualified annuity contracts made to you before you reach age 59 ½ are subject to an additional tax of 10%.”
If your annuity is not qualified, you can use the General Rule to determine the taxable portion of your withdrawal, otherwise, you can use the Simplified Method.
Schedule for systematic withdrawals.
Upon reaching a certain age, the IRS imposes what it calls “required minimum distributions” and imposes a penalty for “excess accumulation.”
If you own an annuity, you may want to set up a systematic withdrawal schedule to avoid IRS and insurance company scrutiny.
You, as the annuity owner, can customize the amount and frequency of your payments with a systematic withdrawal schedule. Is there a downside to systematic withdrawals? In exchange for lifetime payments, you give up your annuitization guarantee.
The benefit of this withdrawal strategy is that you will gain more control over your finances. But you are also forfeiting the financial security that annuities offer.
Are you under age 59½?
The IRS will apply a 10% federal tax penalty if you withdraw money from your annuity while younger than 59 ½ years old. It is important to note that this 10% penalty will be in addition to any regular income taxes that may apply. Disability, death, and certain payment streams are exempt from the 10% federal tax penalty though.
As such, it might not be wise to purchase an annuity if you expect to need access to money before you reach the age of 59 ½.
Are you required to make minimum distributions?
IRAs and 401(k)s may require minimum distributions (RMDs) if your annuity is held there. You have to take a minimum amount of money out of your retirement account each year as required by the IRS. They usually begin to apply when you reach the age of 72. It is possible to incur penalties for failing to withdraw the minimum amount required by the IRS.
There are no withdrawal requirements for Roth IRAs and non-qualified annuities, both of which are funded with after-tax dollars.
What Is The Best Way To Get Money From My Annuity Without Penalties?
Although it might seem complicated, it isn’t.
Quite simply, you should wait until the surrender period ends before withdrawing from your annuity to avoid all the early withdrawal penalties.
It is important that if you withdraw during the surrender period, you do so within the amount permitted by your contract’s free withdrawal provision. You should also withdraw your annuity after age 59 ½, in order to avoid the IRS tax penalty.
The best way to avoid penalties? Don’t make early withdrawals. Unless you are over the age of 59 ½, wait out the surrender period before purchasing an annuity. By doing so, you can enjoy a tax-free retirement income.
FAQs
1. Is it possible to withdraw all of the money from an annuity?
At any time, you can withdraw money from an annuity. The catch? You’ll only be taking a portion of the contract value when you do so.
Also, depending on whether you want to withdraw your funds or sell your annuity in its entirety for a lump sum of cash, you may need to pay taxes, surrender charges, or discount rates.
2. Can an annuity be withdrawn without incurring a surrender charge?
An annuity can be withdrawn without incurring a surrender charge in a few ways. However, this depends on your provider’s policies and if you meet specific eligibility criteria.
The surrender charge may be exempt from your contract, for example. A few examples of exceptions include taking out 10% each year, losing a job, becoming disabled, or being confined to a nursing home.
Before making any decisions regarding withdrawals from an annuity, it is important to do your research and speak with an expert to determine the best method.
3. How does the free annuity withdrawal provision work?
Depending on the company, you may be able to withdraw up to 10% of your funds during the surrender period. Check your contract to see if you are allowed to withdraw up to 10% of your funds during the surrender period.
4. What is the tax treatment of withdrawals from qualified annuities?
When funds are distributed or withdrawn, qualified annuity payments are taxed as ordinary income, not as capital gains. Also, a 10% early withdrawal penalty will be imposed by the IRS if you take your money out of your annuity before you are 59 ½.
5. Is there an alternative to early withdrawals from annuities?
Short answer? Yes.
Instead of taking an early withdrawal, annuitants can sell their annuities to companies for lump sum payments. As the annuitant is selling his/her right to receive future payments for a period of time, there are no surrender fees associated with the sale of an annuity. But, there are a number of factors that will determine the amount of the lump sum payment.
The post What You Need to Know About Annuity Withdrawals appeared first on Due.
By John Rampton
January 30, 2023
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
