Closing a Fixed Annuity

The annuity company will often send a representative to ensure you understand the penalties for cancelling.
i Stockbyte/Stockbyte/Getty Images

From one perspective, a fixed annuity can be considered the ultimate user-friendly investment. You give an institution some money, and it gives you a guaranteed income in retirement. When they're chosen by an informed investor for the right reasons, fixed annuities can be a useful part of a well-rounded portfolio. Unfortunately, for investors fleeing a down market, they're sometimes the financial equivalent of a bad rebound relationship: you got hurt, so you went looking for something safe. If you're in that position and regretting it, you can close out your fixed annuity, but there's a stiff price tag.

About Fixed Annuities

Annuities are a form of investment that originated in the insurance industry, so its brokers could compete in the lucrative retirement-planning market. Fixed annuities are the original form of the product. You buy one with a lump sump payment or by saving into the annuity for a period of years. Eventually you "annuitize," or convert it to an income. The insurer contractually guarantees your rate of return. It's lower than for other forms of investment, because the company usually guarantees that payment for as long as you live. If must be conservative, because If you outlive your investments, you still get your payments and the company loses money.

Surrender Process

If you decide to surrender an annuity you've bought for all the wrong reasons, start by getting in touch with the company that issued your plan. Ask a representative to send the surrender forms to your address. You'll need to complete and return them and sometimes have your signatures witnessed. Some companies will send a representative with the forms or have you pick them up at a local brokerage. That way, the company can try to save you as a client -- or, less cynically, ensure that you understand the penalties you're facing when you surrender the contract.

Surrender Fees

Annuities are intended for use as a long-term savings vehicle. The companies encourage their clients to leave money in the investment by imposing surrender fees, which are high in the early years and dwindle to nothing by the seventh or eighth. This isn't unique to annuities: mutual funds with a "back-end sales load" do the same thing. However, surrender fees for annuities are higher because the broker was paid a substantial commission. In the early years, fees can be 20 percent or more. There's one exception, however. If you've just purchased your annuity, you have 10 days to rescind the contract without penalty.

The Tax Hit

Solid retirement planning is beneficial to the nation at large, reducing the strain on various social programs, so the government encourages savings with various tax incentives. As with a 401(k) or IRA, your investment can grow tax-free within the annuity. However, if you surrender your annuity, every penny of growth becomes taxable as ordinary income rather than a capital gain. That's important, because the tax rate on capital gains is much lower. The impact is magnified if there's been enough growth to push you into a higher tax bracket. If you're younger than 59 1/2, the IRS will also levy an extra 10 percent charge on that income.

the nest