Annuities are prevalent and often effective options for reliable income when approaching retirement age or as an investment that is often tax-deferred. You may have heard about them in commercials or through the grapevine among older family members, et cetera. In many cases, they provide guaranteed income over time, which can be huge for people wanting to leave the workforce or develop a robust investment portfolio.
In some instances, those that qualify can lock in guaranteed annuity rates, but it may beg the question: Can I cancel my annuity later if I decide it’s not a good option for me? Does it depend on the type of annuity I have?
In this article, we’re going to answer this question and more, as well as break down the different types of annuities that exist and how they compare to other types of retirement income, like a 401k.
What is an annuity?
According to Forbes, an annuity is “an insurance contract that exchanges present contributions for future income payments.” This can be funded through a lump sum payment or monthly payments.
Once funded, an insurance company will make allocated payments for a specific period. This can be for a five- or 10-year span or guaranteed payments for the rest of your life. Different types of annuities are available.
Types of annuities
The main difference between the types of annuities is how their payouts are structured. Understanding the specific differences between them is essential before deciding to invest in an annuity.
First, there are deferred and immediate annuity contracts. Deferred annuities don’t begin to make payments until at least a year after you choose them. As its name suggests, an immediate annuity will begin payments to you almost immediately — within a year of your purchase.
You generally fund an immediate annuity with a lump sum payment. In contrast, deferred annuities have an annuitization period, where your investment is given time to grow before you begin receiving payments.
Then there are three main types of annuities, as described below:
- Fixed annuities – These annuities provide a guaranteed minimum annual income, ensuring a fixed amount of money from the contract each year.
- Variable annuities – These annuities’ payments vary on market performance. You choose a particular string of investments; then, your payments depend on their performance. These can pay off massively or come back to bite you.
- Fixed-indexed annuities – These annuities track certain market indexes and often limit how much you can either gain or lose within the annuity.
Finally, there are single-premium immediate annuities (SPIAs) and qualified longevity annuity contracts (QLACs). These can provide a guaranteed stream of income in later years.
What are the benefits of annuities?
Three primary benefits of purchasing or investing in annuities are:
- It can provide reliable income through predictable payments – This allows you to retire and still have a reliable income.
- It allows for tax-deferred growth – Your investments can grow tax-free to get the total amount when you receive payments.
- You can still receive payments after you pass away – Certain death benefits come with annuities in situations where a beneficiary can still receive payments after the annuity purchaser’s death.
However, be wary when choosing your annuity. High fees can be involved, and a long-term contract could make you feel stuck if you choose the wrong annuity.
What if I no longer want the annuity I purchased?
You can surrender the annuity you purchased to rid yourself of it. But depending on a few factors, it may cost you. You may have to pay a surrender charge if you’ve owned the annuity for less than seven years.
The formal surrender starts at 7 percent of the purchase price if you withdraw within the first year but can be up to 20 percent, depending on your annuity contract. You’ll have to pay income tax on your annuity earnings. If you’re younger than 59.5, you’ll likely be hit with a 10 percent withdrawal penalty.
You can conduct a 1035 exchange when you transfer your money to another annuity. You can conduct a 1035 exchange when you transfer your money to another annuity. You can avoid a tax penalty. You might pay more, and your “surrender clock” could reset, forcing you into more years of percentage points.
In other words, you should refrain from withdrawing or canceling the annuity during the surrender period. It will end up costing you. The best way to avoid this is to do extensive research, or receive expert advice, before purchasing an annuity.
But some situations can make things tricky. In some instances, like in a divorce, an annuity can be split in half for both parties, but a trusted family law attorney can help sort through the mess if it gets ugly between the two spouses. But it does depend if the annuity was purchased before or during the marriage.
Conclusion – can you cancel an annuity?
While annuities can be solid choices to ensure reliable income as you approach retirement or as a vehicle to grow investments in a tax-deferred model, they are generally meant to be long-term contracts.
This means removing yourself from an annuity contract or canceling it altogether without paying a significant fee can be challenging. But after six to eight years, the surrender charge that comes with most annuities will disappear, allowing you to withdraw from your annuity without paying; but you have to do time first.
Make sure you have a trusted financial advisor to help you choose the right annuity for your situation, whether it’s fixed, variable or fixed-indexed annuities.
