If you want to surrender, or cash in, an annuity or a permanent life insurance policy, you may have to pay a surrender charge. This is a fee the company imposes on your for taking your money early, like if you cash out an annuity during the surrender period, which usually lasts six to eight years after you buy the annuity. At the time of publication, the tax rules are in flux. The IRS says surrender charges are never deductible, but judges in one court case disagreed. You might need to consult a tax professional about the current state of the law.
The law is very clear that you can't claim losses on an annuity or permanent life policy until you cash it in. Suppose you have a $100,000 annuity that drops in value to $75,000. You have no loss until you surrender the annuity. At that point you may be able to write off the loss. If you pay a surrender charge as well, the IRS position is that the charge is not deductible -- you have to eat the loss.
Loss vs. Gain
In one 2013 case, the Ninth Circuit Court sided against the IRS over surrender charges. A married couple discovered the surrender charge on their life insurance wiped out the value of cashing in the policy. The IRS said the couple still had to report the value as income. A tax court disagreed, saying it was reasonable to consider how surrender charges affect the fair-market value of the policy. In this case, the court said, the charge cut the value to zero, so there was no taxable income. The Ninth Circuit agreed.