Annuities are income vehicles. An annuity is a contract with an insurance company to provide a steady stream of income in the future in exchange for cash, or "premium," now. Annuity withdrawals are taxable as income, except when the balance is rolled over into another annuity. Surrender charges are not deductible.
When you purchase an annuity, the agent who put out the effort to market and sell it to you must get compensated. You don't write the check, however, like you would with a mutual fund. Instead, the insurance company pays the agent. To ensure the insurance company recoups the cost of selling the annuity, it will typically impose a surrender charge on its products if you exit the product within a certain number of years.
Your tax basis is the total number of after-tax dollars you have invested in the annuity contract. If you decide to sell the annuity and the surrender value is more than you paid into the contract, the Internal Revenue Service will charge income tax on the difference between your basis and the sale price.
If you cash out an annuity for less than you paid for it, the IRS will allow you to take that loss and use it to offset gains elsewhere in your portfolio, or income. Unlike other capital losses, however, annuity losses cannot be carried forward to offset gains or income in future years.
Deductibility of the Surrender Charge
Since you didn't pay the salesperson's commission, you don't get to deduct the surrender charge. Instead, your loss is already accounted for in the surrender value of the annuity. You would be accounting for surrender charges twice if you claimed a loss on an annuity and tried to deduct the surrender charge in the same year. Your surrender value that you receive is already net of surrender charges.