Can I Deduct a Surrender Charge on an Annuity?

An annuity can be an excellent way to add an income source to your retirement. Annuities are purchased through insurance companies. You pay into them for a certain time, and then you begin receiving payments. They are a popular way to boost your retirement income, but they are not the most flexible investment instruments. If you do not understand the penalties, such as surrender charges and tax penalties, they can end up costing you a significant portion of your planned income.

Annuity Surrender Charges

What are annuity surrender charges? The surrender period is an amount of time stated in the contract in which you must keep your money in the funds. If you do not, you must pay surrender charges. The most common surrender period is seven or eight years, but there are annuities with periods between zero to ​15​ years. The clock starts as soon as you deposit money into your annuity.

Surrender charges are usually stated as a certain percentage for a certain amount of money – for instance, ​eight​ percent for every ​$1,000​ withdrawal. In many contracts, the surrender charges decrease over time. For instance, the surcharges might be ​seven​ percent the first year, ​six​ percent the second year and ​five​ percent the third year down to zero.

Some contracts allow you to take money out whenever you want, but you will pay a ​10​ percent surrender charge for doing so. Others do not allow you access to your money at all during the surrender period. The best thing to do is to read your contract thoroughly before signing and handing over your money.

Annuity Withdrawal Tax

How much tax do you pay on an annuity withdrawal? Taxes are another issue that affects your annuity and the penalties you will pay. Surrender charges are a punishment that is meant to serve as an incentive for keeping your money in the account. You might also have to pay tax penalties on top of the surrender charges on the money you withdraw.

These charges and penalties are designed to make you stop and think before you treat your annuity or IRA like a savings account. Before deciding to dip into your retirement annuity for a vacation, you need to consider the real costs when you count in the charges. Then, you must ask yourself if it is worth it.

The rules for taxation on early withdrawal of an IRA or annuity are complex, so before you decide to make the withdrawal, talking to a tax advisor so that you know all the implications might be a good idea.

Annuity Surrender Charge and Taxes

Are annuity surrender charges tax-deductible? If you pay surrender charges for an advance withdrawal on an annuity, these charges are not tax-deductible. Some IRAs also have surrender charges, and these are not tax-deductible either.

The next thing you might be wondering is why you would purchase an annuity with surrender charges. The answer to this is that they might have bigger benefits or potential for gain. For instance, you might receive a higher rate of return or receive other incentives when you accept an annuity with surcharges. One thing to be aware of is that some annuities have extended surrender periods that will lock you in for more than ​seven​ years.

Some annuities have a rule that allows you to take up to ​10​ percent every year without a surrender charge. Others have waivers, such as if you receive a diagnosis of terminal illness or go into long-term care that can help you avoid surcharges. When considering an annuity with surrender charges, you must weigh it against the potential that you will need to withdraw the money early. Sometimes, unexpected events happen that cannot be predicted, and you need to consider these risks.