What Is a Surrender Charge?
A surrender charge (also called an early withdrawal charge or contingent deferred sales charge) is a penalty applied when you take out more than the permitted free withdrawal amount from an annuity during the surrender period. It is expressed as a percentage of the amount withdrawn and typically declines each year until it reaches zero at the end of the surrender period.
How Surrender Charges Are Structured
A typical surrender charge schedule might look like this over a 10-year period:
Year 1: 10%, Year 2: 9%, Year 3: 8%, Year 4: 7%, Year 5: 6%, Year 6: 5%, Year 7: 4%, Year 8: 3%, Year 9: 2%, Year 10: 1%, Year 11+: 0%
The declining schedule rewards you for staying in the contract. Most contracts also allow a free withdrawal each year — typically 10% of the accumulation value — without any surrender charge.
Why Surrender Charges Exist
When you purchase an annuity, the insurance carrier funds its promises by investing your premium in long-duration assets. Surrender charges compensate the carrier for the cost of early liquidation and the commissions paid to the selling agent. In many cases, there is no upfront sales charge because the surrender period serves that function.
Surrender Charges vs. IRS Penalties
These are separate and both can apply if you are under age 59.5. The insurance carrier charges the surrender charge; the IRS charges a 10% early distribution penalty on taxable earnings withdrawn before 59.5. Both can apply simultaneously, making early withdrawal from a deferred annuity particularly costly for younger owners.