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You have two ways to access immediate cash from your annuity or structured settlement: withdraw funds from your annuity or sell the right to future payments. If you decide to sell payments, you may sell a number of payments or a specified dollar amount. But no matter which solution you choose, be aware that taxes, fees and penalties may apply.
If you’ve exhausted all your options and made an informed decision to cash out part of your annuity to address a pressing financial need, withdrawing money from this income-generating asset isn’t your only option.
You can also sell your payments to an annuity buyer if the withdrawal charges and tax penalties are too high.
Selling vs. Withdrawing
Withdrawing money from an annuity involves working with the insurance company that issued your contract. You may face fees and penalties for early withdrawals.
In addition, you cannot withdraw money from an annuity that was created to fund a structured settlement. Only annuities bought as part of a long-term financial strategy to guarantee income later in life allow you to withdraw funds.
In contrast to making withdrawals, selling an annuity involves transferring future payments to a third party, known as a factoring company.
In exchange for giving you cash up front, the factoring company that buys your annuity payments will want something in return — a profit. And this profit will come in the form of a discount.
The difference between what your payments are worth and what the factoring company gives you is called a discount rate. This number varies depending on the amount you’re selling, the date that the company will receive the payments, and the current market conditions.
In many cases, the discount rate associated with selling part of your annuity is less than the fees and taxes you would owe after withdrawing money.
Withdrawing Money from Your Annuity
Withdrawing money from your annuity can trigger some steep penalties, so you need to know the terms of your contract and the laws that apply to your situation before you act.
Insurance Companies Enforce Penalties for Withdrawals During the Surrender Period
If you take money out of an annuity, you may face a penalty or a surrender fee, also known as a withdrawal charge.
Annuity contracts include surrender charges to make up for the insurance company’s loss if you choose to withdraw before they can earn interest on your principal. These charges typically decline every year as the annuity becomes older and earns interest the insurance company can keep.
According to the Insurance Information Institute, penalties are also meant to discourage annuity owners from using deferred annuities as short-term investments for quick cash.
A surrender period is the amount of time that you must keep your funds in an annuity to avoid paying penalties to the insurance company.
You can often withdraw up to 10 percent of your account value without facing these extra fees. However, if you withdraw more than is stipulated in your contract, you may still have to pay a penalty — even after the surrender period has ended.
Some annuity contracts will waive these charges for special situations, such as nursing home confinement or terminal illness.
It’s important to note that not every contract allows you to make withdrawals. Review your contract and speak with someone from your insurance company if you have questions.
IRS Tax Penalties for Early Withdrawals
Withdrawing funds from your annuity can also incur tax liabilities. If you withdraw funds before you turn 59 ½ years old, the IRS will charge you a 10 percent penalty.
This is similar to the penalty you face for withdrawing money from a 401(k) or similar retirement savings plan before turning 59 ½. That’s because annuities, like 401(k)s, are designed to be long-term income generating vehicles for retirement.
Withdrawing funds from your annuity can come with expensive fees and other penalties. That’s why many choose to sell the right to their future payments instead.
In order to determine which option is right for you, you must consider the costs associated with selling your annuity payments, the various options for selling, and how they stack up against the financial consequences of withdrawing funds.
Partial Sale: Selling a Number of Future Payments
There are a couple of ways to sell part of your annuity: a partial sale and a lump-sum sale. This flexibility allows you to tailor the transaction to your needs.
In a partial sale, you can either sell your right to receive a certain number of future payments or sell the payments that are scheduled for a certain period of time. The specifics differ depending on the type of annuity you have, how many payments you’ve received, which payments you’re looking to sell, and when the disbursement period ends.
For example, if you bought a 15-year period certain annuity, but you need enough money now for a down payment on a house, you can sell your payments from years one through three in exchange for cash. For those three years, you won’t receive payments, but they will resume when the period ends.
In another example, your structured settlement may pay out $1,000 per month and an additional $5,000 every year for 20 years. You decide to go back to college, and to finance the tuition, you sell your first five annual payments.
Lump-Sum Sale: Selling a Dollar Amount of Your Settlement or Annuity
Lump-sum sales allow you to receive a specific amount of money — $20,000 for example — instead of a certain number of payments that might not total the precise amount you need.
You can customize the way this money is deducted from your payout.
For instance, you might need $85,500 to move your parents into a nursing home. If the factoring company you work with uses a discount rate of 10 percent, you will need to sell $95,000 of your annuity.
Discuss your options with the company that purchases your annuity.
Taxes on Annuity Withdrawals and Sales
Whether or not you pay taxes on withdrawals or payment sales depends on the tax status of the annuity.
When taking money from an annuity that was purchased with after-tax money, taxes are applied only to interest and earnings. For example, if you buy a $50,000 fixed or variable annuity and the value grows to $75,000, the first $25,000 you withdraw is taxable. The remaining $50,000 is not subject to taxes.
Withdrawals are taxed until all interest and earnings are withdrawn.
If, however, you purchased your annuity with money from a tax-deferred retirement account, such as a 401(k), you will have to pay ordinary income taxes on the entire amount you withdraw.
The same applies to selling annuity payments. If you’re selling payments from an annuity bought with pre-tax money, that is, a qualified annuity, they are taxed the same as an ordinary annuity withdrawal.
Like our earlier example, if you sell part of a $50,000 annuity purchased with after-tax funds and currently worth $75,000, you will owe taxes on only the first $25,000 you sell. The remaining $50,000 — your principal — is not subject to taxes because you’ve already paid taxes on that income.
Selling structured settlement payments is different. In most cases, you can sell the right to these payments to a factoring company without paying taxes on the lump sum you receive. As always, though, there may be some exceptions, so it’s wise to consult with an advisor before selling structured settlement payments.
Selling Additional Future Payments
One of the biggest advantages to selling some of your payments is the ability to sell more in the future if the need arises.
If you’ve already sold a portion of your payments but another financial emergency comes into play, you have the option of selling additional payments.
As long as you have not depleted your annuity funds, you can make as many transactions as you need to.
3 Cited Research Articles
- Insurance Information Institute. (n.d.). What are surrender fees? Retrieved from https://www.iii.org/article/what-are-surrender-fees
- Insured Retirement Institute. (n.d.). Taxation on Annuities. Retrieved from https://irionline.org/government-affairs/annuities-regulation-industry-information/taxation-of-annuities
- U.S. Securities and Exchange Commission. (n.d.). Fast Answers: Variable Annuity Surrender Charges. Retrieved from https://www.sec.gov/fast-answers/answersannuitysurrenderhtm.html