Glossary
Surrender charge, defined
A penalty an insurer deducts when the owner withdraws more than the permitted amount or cashes out an annuity or permanent life policy during its early years. It exists to recover the commission and setup costs the carrier paid at issue before the contract has earned them back.
In practice
The schedule is printed in the contract as a declining percentage over a set number of years, and it starts again on each new deposit under some contracts and on the whole contract under others. Free withdrawal provisions usually let a portion out each year without the penalty. The charge is separate from income tax and from any early withdrawal penalty the tax code imposes; a large early withdrawal can suffer all three. Many contracts waive it on death, terminal illness, nursing home confinement or annuitisation, and the waivers are worth reading before buying. A contract still inside its schedule is rarely a good candidate for replacement, whatever the new product offers.
A worked example
Suppose an annuity has a schedule of 7%, 6%, 5%, 4%, 3%, 2% and 1% over seven years, and the owner surrenders $50,000 in year three. The insurer deducts 5%, or $2,500, before paying out the balance. Waiting until year eight would avoid the deduction entirely. Hypothetical figures.
Applies to: Annuities