Annuities are a bit like your granny's old carpetbag: They might be kind of ugly and old-fashioned, but you can use one to pack away a whole lot of money over time. That's great, until the day comes that you need some of your money back. Unlike a carpetbag, annuities usually make you pay a price for early withdrawal.
Annuities are intended as long-term investment vehicles, so the goal is to leave your money in place and let it grow. Unfortunately, life's unexpected needs and emergencies don't always allow you to do that, so many annuity contracts allow for partial withdrawals. That way you can have access to some of your money without having to surrender the whole annuity. One common provision lets you withdraw up to 10 percent of the previous year's value without paying a penalty. Another option allows you to withdraw the gains from your contract -- leaving the principal in place -- without a penalty. If you're shopping for an annuity, look for one with options like these.
Sometimes you'll need to recover funds from your annuity because of a significant hardship. Most annuity contracts cover catastrophic scenarios through waivers, which let you surrender the annuity or make a partial withdrawal without paying the usual penalties. These waivers are usually triggered by a major medical emergency, such as being diagnosed with a terminal illness or confined to a nursing home. This gives you or your family access to funds that otherwise would remain tied up until you reach retirement age or die.
In some circumstances, you might opt to simply surrender your annuity contract. That'll hurt during the first several years of your annuity, while the company is recovering the costs of underwriting the contract. Surrender fees can range as high as 25 percent at first, but they'll dwindle over time. In most cases, they drop to zero after nine or 10 years. It's important to take the surrender charges into account when you decide to cash out your annuity prematurely. On the other hand, if the contract has been in place for some time, the IRS might take a bigger bite.
When you cash in your annuity, it'll contain two kinds of money. You won't be taxed again on your capital, which you pay with after-tax dollars. However, every penny of gain you've accumulated becomes taxable. Even worse, it's considered ordinary income rather than capital gains, which are taxed at a lower rate. If you make partial withdrawals, they're considered to be taken from your gains -- and therefore taxable -- until you've withdrawn all the growth. If that isn't bad enough, you'll also pay an extra 10 percent tax penalty if you aren't at least 59 1/2 when you make the withdrawal.
Fred Decker is a trained chef and certified food-safety trainer. Decker wrote for the Saint John, New Brunswick Telegraph-Journal, and has been published in Canada's Hospitality and Foodservice magazine. He's held positions selling computers, insurance and mutual funds, and was educated at Memorial University of Newfoundland and the Northern Alberta Institute of Technology.