What is an Annuity Surrender Charge?
It is very important to understand what is an Annuity surrender charge and the fees and penalties. It is usually the determining factor in the decision to purchase or not purchase an annuity.
During the surrender period of an Annuity, which is usually 10 years or less, you are allowed to withdraw the interest you have earned or up to 10% free withdrawal of your annuity value per year without any cost, penalty, or fee. If the withdrawal from your Annuity exceeds the contractually outlined free withdrawal amount, you may incur a surrender charge. The most common type of surrender charge is a fee based on a percentage of the amount you withdrawal from your annuity. It is common for this fee to decrease over the life of your annuity. This surrender charge percentage will typically decrease over a seven to ten year period, and then be eliminated completely.
An example of a seven-year surrender charge schedule would look like this. 8% In the first year, followed by 7% in the second year, then followed by 6%, 5%, 4%, 3% and finally 2% in the seventh and final year. In the eighth year of the Annuity in this example, the Annuity holder would not be charged a surrender fee for taking any size withdrawal from the Annuity.
Keep in mind that your surrender charge does not include any income tax you may pay, nor does it include any withdrawal penalty you may be charged if you are below the age of 59 1/2.
Let’s look at an example. Let’s say Mort purchases a $10,000 Annuity. The annuity agreement outlines an annual allowable withdrawal amount of 10% of the annuity value, and defines a surrender charge schedule of 8% in the first year, declining down 1% each year until it reaches 2% by the seventh year.
Mort creates his $10,000 Annuity and does not take any withdrawals from the annuity in year one.
In year two, Mort’s annuity has grown to $10,500 when he comes across a hot investment he would like to fund with $3000 currently sitting in his Annuity.
Mort reviews his surrender charge schedule and determines that he can withdraw up to 10% of his Annuity ($10,500 X 10% = $1,050) without penalty.
Any money over $1,050 will be subject to his second-year surrender charge schedule (6%).
Mort calculates that only $1,950 of his $3,000 withdrawal will be subject to a surrender charge ($3,000 withdraw amount – $1,050 allowable annual withdrawal = $1,950).
Mort is charged a surrender fee equal to 6% X $1,950 = $117.
Mort’s Annuity value after his withdrawal is $7383. ($10,500 year two Annuity value – ($3,000 withdrawal amount + $117 surrender charge) = $7,383).
What is a Market Value Adjustment?
A market value adjustment (MVA) is the increase or decrease in the value of the assets held by the insurance company. This increase or decrease in value can be passed on to the client to help create an annuity that can offer more client friendly features. This adjustment is typically only passed on to the client on withdrawals in excess of the free withdrawal amounts which includes full surrender.
The Market Value Adjustment is only applied when the contract is surrendered during the surrender period. When the contract is outside of the surrender period, MVAs do not apply.
MVAs have a negative connotation for some, but there are times when MVAs actually benefit clients. MVAs allow the insurance company to give a client more upside potential because they are sharing risk and benefit with the client. The insurance company issues an annuity contract with the understanding that the client is committing to the length of the contract. They buy bonds of a certain duration based on that client commitment. When a client surrenders a policy early, they are breaking that commitment.
This can throw off the insurance company’s pricing if there has been a change in interest rates from when the policy was issued to when the policy is surrendered. The MVA is a way for the insurance company to reconcile with the client based on interest rate movement and adjust the surrender charge accordingly.
How Today’s MVAs May Benefit Your Account
MVAs are based on the 10-year treasury, so if the 10-year treasury was lower when the policy was issued than it is when the policy is surrendered, it will cause the MVA to be negative. When an MVA is negative, it subtracts dollars from your client’s surrender value, meaning the surrender penalty to your client is greater. If the 10-year treasury was higher when the policy was issued than it is when the policy is surrendered, it will cause the MVA to be positive. When an MVA is positive, it adds dollars into your client’s surrender value, meaning the surrender penalty to your client is less. Once again, it is important to note that MVAs only apply to surrendering the contract during the surrender period.
Next: Guide To Fixed Annuities
