Whether to keep an annuity comes down to four numbers: the cash you’d get if you left today, what the contract costs each year, what its guarantees are worth to you, and the tax due on the gain. Keep it when you’ll use the guarantees and the costs are fair for them. Leave or exchange it when you’re paying every year for features you won’t use and the surrender charge is small or gone. The SEC puts the mortality and expense charge on a variable annuity at about 1.25% a year, before administrative fees, fund costs and riders. A fee-only planner paid by the hour, a median $300, can run the numbers without earning anything from the answer.
Our glossary explains the kinds of annuity and how a surrender charge works.
Get the four numbers first
Ask the insurer, in writing, for:
- The surrender value today: the contract value minus any surrender charge, in dollars. Also ask when the charge ends.
- Every yearly charge, as a percentage and in dollars: mortality and expense, administration, each rider and the fund expenses. The SEC gives about 1.25% for mortality and expense and about 0.15% for administration as typical, and says riders “often carry additional fees and charges.”
- What each guarantee is. For a death benefit, the amount your heirs would get against today’s contract value. For an income or withdrawal rider, the guaranteed payment and the age it starts. On many contracts the “income base” is only a figure used to work out that payment, not cash you can take.
- Your cost basis and gain, if the annuity is outside an IRA. The gain is what you’d pay tax on.
Also ask for an in-force illustration, a projection run on your contract as it stands today. It shows how the guarantees and costs play out over the years ahead.
The rules that decide the math
Withdrawals are taxed gain first. For an annuity bought outside a retirement account, the IRS says a withdrawal is “allocated first to earnings (the taxable part) and then to your cost.” Earnings are taxed as ordinary income, not at capital-gain rates, and the SEC notes a 10% additional tax on withdrawals before 59½. Surrendering the whole contract makes the whole gain taxable in one year.
Inside an IRA, the annuity adds no tax benefit. The SEC says that in a tax-advantaged account “you will get no additional tax advantage from the variable annuity.” The only question there is whether the guarantees are worth what they cost.
A 1035 exchange moves money without tax. Federal law lets you exchange an annuity for another annuity, or life insurance for an annuity, without tax. An annuity into life insurance isn’t one of the swaps the law allows. You can also move part of a contract: the IRS treats a partial exchange as tax-free if nothing is withdrawn from either contract for 180 days.
An exchange can restart the clock. The SEC warns that “a new surrender charge period generally begins when you exchange into the new annuity.” For variable annuities, FINRA Rule 2330 requires a broker recommending an exchange to consider surrender charges, a new surrender period, lost benefits and higher fees, and whether you’ve had another exchange in the past 36 months. A principal at the firm must review it.
Insurance agents have a best-interest rule too, in most states. The NAIC’s 2020 revision of its annuity model regulation requires recommendations “in the best interest of the consumer.” The NAIC counted 40 states that had adopted it as of November 2023.
Annuitizing is usually permanent. FINRA says “the decision to annuitize is generally irrevocable.” You trade the balance for a stream of income.
Your heirs don’t get a step-up. Stocks you own get a new cost basis at death; see step-up in basis. An annuity’s death benefit is taxable to the extent it exceeds the unrecovered cost, so your heirs owe income tax on the gain.
Your options
How fast the surrender charge falls often settles whether to wait. In the SEC’s example, a 7% charge in the first year after a payment drops about a point a year and ends in the eighth.
On a $200,000 contract, the difference between a 5% charge and a 2% charge is $6,000, based on that example schedule. Set that against the yearly fees you’d pay while you wait.
| Option | When it tends to fit | Watch for |
|---|---|---|
| Keep it as it is | You’ll use the income or death guarantee, and the costs are fair for it | Paying yearly for a rider you’ll never use |
| Take free withdrawals | You need some cash; many contracts allow about 10% or 15% a year without a surrender charge, the SEC says | Tax on the gain, and the 10% additional tax before 59½ |
| Exchange to a lower-cost annuity | You want tax deferral or a guarantee at less cost, including versions sold without commission | A new surrender period, and losing a valuable death benefit |
| Wait, then leave | The surrender charge ends soon | Paying the yearly costs in the meantime |
| Surrender now | The charge is small or gone, and the gain or tax rate is low | The whole gain taxed in one year |
| Annuitize | You want guaranteed lifetime income from this money | It’s generally irrevocable |
Common mistakes
- Surrendering in a high-income year. Leaving in the year after you retire, or splitting the move across two tax years, can cost less tax.
- Dropping a death benefit worth more than the contract. After a market fall, the guaranteed death benefit can exceed the contract value. Surrendering gives that up.
- Exchanging for a bonus. The SEC says bonus credits, typically 1% to 5% of payments, can come with “higher expenses that can outweigh the benefit,” often through higher or longer surrender charges.
- Paying a percentage on the money you free up. An advisor paid a share of assets earns more if you surrender into an account they manage. At the median 1%, moving $300,000 adds $3,000 a year to their fee, based on that rate. That’s a conflict even for a fee-only advisor, so ask.
- Getting the review from the person who’ll sell the replacement. Our guide to warning signs covers what a replacement pitch looks like.
Questions to ask whoever reviews it
| Ask | A good answer includes |
|---|---|
| What would I get if I left today, after charges and tax? | A dollar figure for both |
| What does this contract cost me each year, in dollars? | Every charge added up, riders included |
| Will I actually use the riders I’m paying for? | A yes or no tied to your income plan |
| What would a lower-cost contract give me instead? | A named alternative, with its surrender schedule |
| How are you paid if I keep it, exchange it or surrender it? | The same answer all three ways |
When a fee-only advisor is worth it, and what it costs
A review is worth paying for when the contract is large, the surrender charge is still running, or the annuity is meant to be part of your retirement income. If it’s small and the charge has ended, the four numbers above may be all you need.
Fee-only planners who publish prices charge:
- Hourly: a median of $300 an hour, middle half $250 to $350. A single contract review fits here. See hourly planner costs.
- One-time plan: a median of $2,000, if the annuity is one piece of a retirement income plan. See one-time plan costs.
- Ongoing planning: a median of $4,500 a year.
An hourly or flat fee keeps the advice independent of what happens to the money. A fee-only advisor can still recommend an annuity, usually a version without a commission, and earns nothing from the choice.
How to find one
Start with the retirement planning specialty or the list of retirement planning specialists in the public graph. Advisors for retirees and pre-retirees see annuities often, and flat-fee advisors charge a price that doesn’t change with what you decide. Bring the contract, your latest annual statement and an in-force illustration to the first meeting. Our guide to retirement advisors covers the income plan an annuity should fit into.