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A surrender charge is a fee which is charged when someone cancels or cashes out an annuity before it matures. Ostensibly, surrender charges are designed to compensate the institution which administers the annuity for the cost of managing and maintaining the annuity; under normal circumstances, the routine fees associated with the annuity cover these costs, but when the annuity is canceled early, these costs have not yet been recouped. Information about surrender charges is included in the contract signed when the annuity is purchased, and it is a very good idea to read through such contracts closely.
Annuities are designed to provide people with set, predictable income. They are usually structured in a way which makes them tax-free, and intended for people to use for income during retirement. Annuities can be purchased through life insurance companies and other types of financial institutions, and they are viewed as a long term investment. Many of the terms in the structure of an annuity are specifically designed to penalize short term investors, which is something to be aware of.
When an annuity includes a surrender charge, if someone attempts to cash it out before it is mature, he or she will forfeit a percentage of the value of the annuity. The percentage starts out high, dwindling to zero over the course of the annuity's lifetime. Someone who cashes out an annuity after a year, for example, might have a surrender charge of 10%, while someone who cashes out after 15 years might incur no surrender charge. The length of the term varies depending on the organization which issues the annuity.
Another issue with the surrender charge is that when an annuity is cashed out early, it often triggers tax penalties. This means that in addition to paying fees for early cancellation, investors would also incur tax liability which could significantly drive up the cost of cashing out early. People should consult their accountants before cashing out an annuity, keeping in mind that the funds are highly illiquid and that as a general rule people should avoid cashing out an annuity before it is mature.
Some financial advisors feel that annuities are not very sound investments because they penalize short term investment, and they can come with highly restrictive terms which can be come problematic. People who are interested in buying annuities may want to consult an accountant or financial advisor to get advice on the best product to buy, and certain things to avoid.
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