Withdrawing From an Annuity: Options and Penalties

If you need to get cash out of your annuity, the costs can add up fast. Withdrawing before the surrender period ends or before age 59½ can cost you 20% to 30% in surrender charges, IRS penalties, and taxes. We see people shocked by this number every day. Selling future payments to a buyer like CSF avoids both the surrender charge and the 10% IRS penalty.

Your Options for Withdrawing Money From an Annuity

• Full surrender: Terminate the contract entirely and receive the cash surrender value
• Partial withdrawal: Take some funds while keeping the rest in force
• Free withdrawal provision: Access up to 10% per year without surrender charges
• Systematic withdrawal: Set up regular automated withdrawals
• 72(t) distributions: Series of equal periodic payments that avoid the IRS 10% penalty
• Sell future payments to CSF: Receive a lump sum now in exchange for a portion of your future payment stream, no surrender charge, no IRS penalty

The Free Withdrawal Provision

Almost every annuity contract includes a "free withdrawal" provision allowing you to withdraw up to 10% of the account value per year without surrender charges. Example: $200,000 annuity in year 3 of a 7-year surrender period, you can withdraw up to $20,000 without surrender charge. Important caveat: the IRS 10% early withdrawal penalty may still apply if you're under 59½.

Before using your free withdrawal, check three things in your contract. First, confirm whether the 10% applies to the original premium or the current account value, as contracts define it differently. Second, verify whether unused free withdrawal amounts roll over to the next year. Most contracts do not allow rollovers, so the 10% resets annually. Third, check whether the free withdrawal resets the surrender period clock. In most contracts it does not, but some variable annuity contracts have different rules. Your annuity statement or certificate page lists the exact free withdrawal terms.

The IRS 10% Early Withdrawal Penalty Under IRC §72(q)

The IRS treats annuity withdrawals before age 59½ the same way it treats early withdrawals from IRAs and 401(k)s: it imposes a 10% penalty on the taxable portion of the withdrawal under IRC §72(q). This penalty is in addition to ordinary income tax on any gains. For a $50,000 withdrawal with $30,000 in gains, the 10% penalty alone costs $3,000, on top of whatever income tax you owe on the $30,000.

When the 10% Penalty Applies

The penalty applies any time you take money out of a non-qualified annuity before turning 59½, with a few narrow exceptions. The age 59½ rule is the same threshold used for IRAs and 401(k)s. If you are 55 and surrender your annuity or take a partial withdrawal, you owe the 10% penalty on every dollar of taxable gain. There is no pro-rata exception and no hardship waiver.

When the 10% Penalty Does Not Apply

IRC §72(q)(2) lists specific exceptions. The penalty does not apply if the distribution is made after the annuity holder turns 59½, is made because of the holder's death (payments to a beneficiary), is attributable to the holder becoming disabled as defined by IRC §72(m)(7), or is part of a series of substantially equal periodic payments under IRC §72(t) (commonly called a "72(t) distribution"). For IRA-based annuities, a qualified first-time home purchase also qualifies. The IRS provides additional details in Publication 575.

Selling future payments to CSF is not considered a "withdrawal" by the IRS. You are selling a property right (the right to receive future payments), not withdrawing funds from the annuity contract. The contract stays in place, and the 10% penalty does not apply. This distinction matters most for people under 59½ who need a large sum. Surrendering a $150,000 annuity with $80,000 in gains at age 45 triggers an $8,000 penalty on top of income taxes. Selling those same future payments to CSF avoids that $8,000 cost entirely.

Surrender Charges: What They Are

A surrender charge is the insurer's fee for terminating your annuity contract during the surrender period. Your state's department of insurance can help you understand your contract rights.

How the Typical 7-Year Declining Schedule Works

Most fixed and fixed-indexed annuities use a declining surrender charge schedule that starts between 7% and 10% in year one and drops by roughly one percentage point each year. Variable annuities from issuers like MetLife, Prudential, and Jackson National often start at 8% or 9%. The schedule below reflects the most common structure we see across carriers.

Contract Year	Surrender Charge	On $100,000 Annuity
Year 1	7%	$7,000
Year 2	6%	$6,000
Year 3	5%	$5,000
Year 4	4%	$4,000
Year 5	3%	$3,000
Year 6	2%	$2,000
Year 7	1%	$1,000
Year 8+	0%	None

Some contracts use longer surrender periods. We have seen 10-year and even 14-year schedules on certain indexed annuity products. Always check your annuity certificate or contract schedule page for the exact percentages and duration. If you cannot find it, your insurer's customer service line can provide the information.

Keep in mind that the surrender charge applies to the amount you withdraw above the free withdrawal allowance. If you have a $200,000 annuity in year 3 (5% charge) and withdraw $60,000, the first $20,000 falls under the 10% free withdrawal provision. The remaining $40,000 gets hit with the 5% charge, costing you $2,000.

Sell Future Payments Instead: The Alternative Most Don't Know

Most annuity holders assume surrendering is the only way to access their money. Selling future payments to a structured settlement buyer is a legally distinct transaction that avoids the two biggest costs of surrendering. When you sell to CSF, the annuity contract stays in place, you're not terminating it. The insurer continues making payments on schedule, but they go to CSF instead of you. This means:

• No surrender charge: You're not terminating the contract, so no insurer fee applies
• No IRS early withdrawal penalty: You're selling future payment rights, not making a "withdrawal"
• You pay nothing out of pocket
• Partial sales available: Sell only the payments you need; keep the rest

Surrendering to Your Insurer vs. Selling to CSF

We have seen hundreds of people try to surrender their annuity before learning that selling payments is even an option. The two transactions look similar on the surface, but the financial outcomes are different. Here is the full comparison.

Factor	Surrender to Insurer	Sell Payments to CSF
What you get	Cash surrender value minus surrender charge minus taxes minus IRS penalty	Lump sum based on present value of sold payments
Timeline	2 to 4 weeks after insurer processes request	30 to 60 days (court approval required in most states)
Penalties	Surrender charge (up to 10%) plus 10% IRS penalty if under 59½	No surrender charge, no IRS penalty
Contract status	Terminated entirely	Stays in force. Payments redirect to CSF
Partial option	Limited to free withdrawal (10%/year) or full termination	Sell any portion. Keep the rest of your payments
Best for	Post-surrender period (0% charge), over age 59½	Still in surrender period, under age 59½, or want to keep some payments

CSF will not be beat on price. If you are comparing options, call us at (800) 317-3769 and we will run both scenarios side by side so you can see exactly what you walk away with under each method. For more detail, see our complete guide on cashing out an annuity.

When Does Surrendering Actually Make Sense?

Surrendering your annuity is not always the wrong choice. If the surrender period has already ended (0% charge), and you are over age 59½ (no IRS penalty), surrendering may be the simplest path. You contact the insurer, request the cash surrender value, and receive a check.

That said, if either the surrender charge or the IRS penalty applies, the combined costs can be substantial. A $100,000 annuity in year 2 of a 7-year surrender period, held by someone under age 59½, could cost $6,000 in surrender charges plus a 10% penalty on taxable gains plus ordinary income tax on those gains. Selling to CSF avoids the first two costs entirely.

If you are unsure which option is better for your situation, CSF can provide a free side-by-side comparison showing what you would receive from surrendering versus selling. Call (800) 317-3769 or visit our annuities page to learn more about how selling annuity payments works.

Frequently Asked Questions: Withdrawing From an Annuity

Can you withdraw money from an annuity without penalty?

Yes, under certain conditions: after the surrender period ends (0% surrender charge), within the annual free withdrawal provision (typically 10% per year), or after age 59½ (no IRS penalty). Selling future payments to CSF avoids both the surrender charge and IRS penalty.

What is the penalty for withdrawing from an annuity?

Two potential penalties: (1) a surrender charge from the insurer, typically 6–10% in year one, decreasing annually; and (2) a 10% IRS early withdrawal penalty if under age 59½. Combined with income tax on gains, these costs can reduce what you receive by 20–30% or more.

What is a free withdrawal provision?

Most annuities allow withdrawal of up to 10% of account value per year without any surrender charge. The IRS early withdrawal penalty (if under 59½) may still apply to the taxable portion of these withdrawals.

Is it better to surrender an annuity or sell the payments?

For most people within the surrender period or under age 59½, selling payments to CSF saves thousands of dollars compared to surrendering. Surrendering triggers the surrender charge AND the IRS penalty AND income tax on gains. Selling to CSF: no surrender charge, no IRS penalty.

What is a 72(t) distribution?

A 72(t) distribution allows annuity or retirement account holders to take regular distributions before age 59½ without the 10% IRS penalty. The payments must continue for at least 5 years OR until age 59½ (whichever is longer). Modifying payments before the required period ends restores the penalty retroactively.

At what age can I withdraw from an annuity without the IRS penalty?

Age 59½, the same threshold as IRAs and 401(k)s. Surrender charges from the insurer may still apply regardless of age until the surrender period ends.