Annuities, Part 5: Getting Out of an Annuity

This article is for people who no longer want an annuity they already own. 

  • Maybe your circumstances have changed and you no longer have a need for an annuity.
  • Maybe you still want the annuity, but you just want access to some of your money.
  • Maybe you still want an annuity, just a different annuity than you currently have.
  • Or maybe you made a mistake from the beginning!

Whatever the reason, this article will discuss some of the more common ways to withdraw money from an annuity, and the potential consequences of doing so. Specifically, we’ll walk through

  • Free look periods
  • Surrender charges
  • Taxation
  • Income annuities

Keep in mind I am not a legal or tax professional, and this article is for educational purposes only. Let’s get to it.

Free Look Period

If you purchase a pair of pants, and they don’t fit, you can usually return them within a reasonable amount of time for a refund. The same thing goes for many annuities in many states due to something commonly referred to as the “free look period.” A free look period is usually a period of time that a consumer has, after purchasing an annuity, to change his/her mind and  receive a refund.

Annuities are issued by insurance companies, and, according to FINRA, “Every state, along with the District of Columbia and U.S. territories, has an insurance commission that licenses the insurance agents and insurance companies who do business in that jurisdiction. State insurance commissions also impose sales and marketing rules and require companies to file financial reports to assess their ability to honor claims.” This means that many rules regarding annuities are implemented and enforced at the state level.

Many, but not all, states have written free look periods for annuities into their laws. 

For example, my interpretation of California’s Insurance Code, Division 2, Part 2, Chapter 1, Article 1, Section 10127.9(a), paragraph 1 is that the free look period for California is usually 10-30 days. See screenshot below.

Another Example is New York. My interpretation of The Laws of New York > Consolidated Laws > Insurance > Article 32 > Section 3219 is that the free look period is usually 10-30 days. See screenshot below.

If your annuity has a free look period, it will often be written into your contract. Below is an example screenshot from the Jackson National Elite Access® Flexible Premium Variable and Fixed Deferred Annuity.

Free looks aren’t usually very long, if you have one at all. But if you recently purchased your annuity, there still may be time to change your mind.

Surrender Charges

If you are beyond your free look period (of if you don’t have a free look period), you may still be able to take money out of your annuity. However, doing so may incur a fee. This fee is usually referred to as a “surrender charge” or a “withdrawal charge” is typically expressed as a percentage, and typically decreases over time.

Annuities are meant to be long-term investments, so surrender charges help discourage short-term thinking amongst those who purchase them. They help the insurance company recoup various upfront costs like marketing, underwriting, and commissions paid to the insurance agent.

Below is an example of a surrender charge from the Allianz 222® Fixed Index Annuity.

Most of the surrender schedules I’ve seen have been between 3-10 years, but each annuity is different, and each state is different. If your surrender period is complete, you may be able to withdraw your money without incurring a surrender charge.

Notably, there are some exceptions to the surrender charge. In the same example as above, it mentions you can access up to 10% of your net premiums paid without incurring surrender charges. 

The 10% annual exception is actually fairly common, so check to see if your annuity has it. There may be other exceptions as well, so check your contract. If you can qualify for one of the surrender charge exceptions, that can help you get some money out of your annuity.

If you can’t qualify for one of the exceptions, you will likely have to pay a surrender charge. Since they usually decrease with time, waiting it out can sometimes make sense. If you must pay a surrender charge, sometimes a break even analysis can be appropriate. For example, if you pay a 5% surrender charge, but will save 1% per year in fees, you would break even in about 5 years. Depending on your investing time horizon, this may/may not make sense.


In addition to surrender charges, you also have to be aware of any potential taxes you’ll incur from withdrawing money from an annuity. Now, that taxation of annuities is incredibly complex, as is apparent from IRS Publication 575, Pension and Annuity Income

I won’t pretend to be an expert on all things related to the taxation of annuities. There are many rules, worksheets and exceptions with annuity taxation that the brief discussion below will not encompass. So please, do your own research and/or consult with a tax professional. But below are the general tax rules to be aware of when withdrawing money from an annuity.

Types of Potential Taxes

1. Ordinary Income

If you purchased your annuity inside a Traditional IRA, then your annuity is usually referred to as a “qualified annuity.” Withdrawals from your qualified annuity will generally be governed by the rules laid out in IRS Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs). Page 4 states that “distributions from a traditional IRA are taxed as ordinary income, but if you made nondeductible contributions, not all of the distribution is taxable.” See screenshot below.

If you bought your annuity outside of an IRA, it is usually referred to as a “nonqualified annuity.” Withdrawals from nonqualified annuities, if taxable, are also usually taxed as ordinary income. To make matters worse, “if you receive a nonperiodic distribution before the annuity starting date from a plan other than a qualified retirement plan (nonqualified plan), it is allocated first to earnings (the taxable part) and then to the cost of the contract (the tax-free part)” (IRS Publication 575, page 17). 

This is commonly called “Last In, First Out (LIFO) tax treatment” and means you will usually pay taxes on a withdrawal if there are any earnings in the annuity. You can see a screenshot and an example below.

2. Additional 10% Tax

If you are under 59 ½, you may also owe an additional 10% tax on top of your ordinary income tax. This is true if the annuity is held inside an IRA (see IRS Publication 590-B, page 22, and the screenshot below).

This is also true if the annuity is held outside an IRA (see IRS Publication 575, page 33, and the screenshot below).

3. Net Investment Income Tax (NIIT)

Finally, if your annuity is a nonqualified annuity, withdrawals may also be subject to the Net Investment Income Tax (NIIT) of 3.8%, depending on your income. For more information on NIIT, see Instructions for Form 8960, Net Investment Income Tax—Individuals, Estates, and Trusts

“In general, net investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, and non-qualified annuities” (IRS). See screenshot below.

As you can see, taxes can add up quickly with annuity withdrawals. You could be hit with with ordinary income tax, an additional 10% tax, and the NIIT all at the same time! And we haven’t even mentioned state taxes, if applicable to you. Luckily, there are ways to minimize, delay or avoid some of these taxes.

Tax Strategies

1. IRA Transfer/Rollover

If your annuity is held within an IRA, according to IRS Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs), “You can transfer, tax free, assets (money or property) from other retirement programs (including traditional IRAs) to a traditional IRA.” See screenshot below.

2. Tax-Free Exchange

If your annuity is held outside of an IRA, you can still do a tax-free exchange of your existing annuity for a new annuity that may better suit your needs. This is commonly referred to as a “1035 exchange” because Section 1035 in the tax code is what allows this. See the screenshot below from IRS Publication 575, page 19. 

3. Tax Analysis

Lastly, even if you must pay taxes, it may still be worth it. Sometimes the fees on annuities are so high that there isn’t very much growth to be taxed in the first place! Similar to with surrender charges, you can always do a breakeven analysis to see how long it would take you to recoup the money you pay in taxes.

Income Annuities

The topics above mainly apply to deferred annuities that are still in their accumulation phase. If you purchased an income annuity, or you purchased a deferred annuity but have already annuitized it, your options are likely fairly limited. This is because annuitization is largely intended to be an irrevocable decision (unless you’re still within your free look period, of course).

However, depending on your contract and your state, you may still have some flexibility.

1. Income Start Date Adjustment 

If you purchased a deferred income annuity, you may still be able to adjust the start date of your income stream. An example is the Pacific Life Pacific Secure Income® Annuity. See the screenshot below. 

2. Accelerated Payments

If you have a liquidity need, you may be able to accelerate some future payments. An example is the New York Life Guaranteed Lifetime Income Annuity II. See screenshot below.

3. Commutation of Benefits

If you have a larger liquidity need, you may be able to commutate your annuity, which is like undoing your decision. An example is the AIG American Pathway Immediate Annuity. See screenshot below.

These options may not be available to you, and there may be a fee that comes along with them. But it’s good to know your options if you’ve already annuitized.


As you can see, not all hope is lost if you have money tied up in an annuity. If you purchased the annuity recently, you may still be in your free look period. If not, make sure to check your surrender schedule and any exceptions to the surrender fee.

Also make sure you are aware of the tax consequences, if any, of pulling money out of your annuity. Consider using strategies such as IRA transfers and1035 exchanges to try to minimize taxes.

Lastly, if you have already annuitized, you may still be able to adjust your income start date, accelerate income payments, or commutate your annuity.

I hope this was helpful.