If you're like many educators who choose a fixed or variable annuity for their 403(b) or 457 plan, you may decide at some point that it is not a suitable investment for you. However, cancelling an annuity contract is not always simple.
Surrender Fees May Last for Years
Most annuities charge surrender fees. These are basically deferred sales fees that are charged when you sell, rather than when you buy, an investment. There are a few vendors that offer annuities with minimal or no surrender fees. More typically, annuities have a surrender schedule that lasts six or seven years. The fee may start at about 6% or 7% initially, then decrease each year until it reaches zero. Some have much higher fees and/or longer terms. Watch out for those plans!
For example, suppose there is an annuity with a surrender schedule that starts at 7% in year one and drops to 6% in year two. An individual with $5,000 in the contract who decides to surrender the annuity in year two would pay 6% x $5,000, or $300 just to cancel the contract.
When Do Surrender Fees Start?
Many annuities' surrender fee schedules are based on the initial date of the contract, not on subsequent deposits to the same annuity. However, some annuities calculate their surrender fees from each premium payment during the surrender period.
Let's look at two hypothetical annuities.
Annuity A bases its surrender period on the date of the policy. It has a seven-year surrender period starting at 7% and dropping one percentage each year. If you purchase the annuity in 2013, you are free of surrender charges by 2020.
Annuity B charges surrender fees based on the date of each premium payment. It also has a seven-year surrender period starting at 7% and dropping a percentage point each year. The first year's payments are free of surrender charges in 2017. However, the clock starts again with the second year's payments, so second year contributions aren't free of surrender fees until 2018, and so on. With this type of surrender schedule, you would not be completely free of surrender charges until seven years after the date of the last payment that surrender charges apply to, so if your last annuity payment is in 2017, the last surrender charge would be in 2024. Or, the annuity might continue surrender charges on new premium payments indefinitely.
So How Do I Get Out?
Once you have entered into an annuity contract, you are tied into the surrender fee schedule. You have a few options if you decide the annuity is no longer appropriate for you:
- Wait out the surrender period until it reaches 0% before cancelling.
- Wait a few years until the surrender charge drops to a lower percentage (something you'd be willing to pay) before cancelling.
- Pay the full surrender fee and cancel the contract.
- Exchange contracts. If you are in a variable annuity and the subaccounts you chose are underperforming, you may be able to switch to different subaccounts without triggering surrender charges, as long as the new subaccounts are with the same vendor and the vendor offers this option.
If you do decide to cancel the contract and do not want to transfer to another subaccount with the same vendor, consider rolling the balance into a 403(b)(7) mutual fund custodial account (or 457 mutual fund account) to continue tax-advantaged retirement savings rather than entering another annuity contract.
What Other Fees May Apply?
If you surrender your annuity to take the money out of your 403(b) plan, you may have more than surrender fees to pay. You will also owe income taxes on the distribution plus a 10% tax penalty if you are under age 59 1/2 and still working, or age 55 if you are leaving your job. (The 10% penalty doesn't apply to 457 plans.)
Be Informed about Fees
Be sure you investigate all charges and surrender fees involved with an annuity or any other investment. Ask for the information in writing, and be sure you understand it. Some annuity contracts have very dense and confusing language. The bottom line: If you don't understand it, don't buy it.