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Surrender Charges Explained

Most annuities allow you to withdraw either your interest earnings or up to 5-10% per year without a penalty (although withdrawals can impact income stream amounts and the death benefit, and may be subject to taxes and a 10% federal penalty if taken prior to 59½ years of age). Beyond that, most annuities have a surrender charge — a penalty for making an early withdrawal above the free withdrawal amount. Typically this surrender charge is a percentage of the amount withdrawn, and decreases over a seven- to ten-year period.

A surrender charge schedule is often depicted as a series of percentages. For example, a surrender schedule of 8%, 7%, 6%, 5%, 4%, 3%, 2% indicates a 7-year surrender period with an 8% charge in the first year after a purchase is made, 7% in the second year, 6% in the third year, and so on until the eighth year, when the surrender charge no longer applies (there are no longer any penalties for withdrawals).

For example, suppose you were to purchase an annuity contract with a $10,000 purchase. The contract has a schedule of surrender charges beginning with 7% in the first year and declining by 1% each year thereafter. In addition, you are allowed to withdraw 10% of your contract value each year free of surrender charges. In the first year, you decide to withdraw $5,000, or one-half of your contract value of $10,000 (assuming that your contract value has not increased with interest earned). In this case, you could withdraw $1,000 (10% of contract value) free of surrender charges, but you would pay a surrender charge of 7%, or $280, on the other $4,000 withdrawn.

This web page has been reviewed for compliance.Document reference: #1500261-4

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