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A piggy bank locked up with a chain

Is your money really locked up when you own an annuity?

by Susan Wright | Contributor
Dec 2nd, 2021


With the near disappearance of the defined benefit pension plan – where recipients can count on a specified amount of income in retirement – many people are now turning to annuities as a type of “personal pension,” as they are designed for paying out a guaranteed income stream.

Annuities can offer other enticing features, as well. For instance, with a deferred annuity, the funds that are in the account can grow on a tax-deferred basis. This is similar to how traditional IRAs and 401(k)s work, where no tax is due on the gain until the time of withdrawal.

But while annuities can certainly provide you with a long list of benefits, these financial vehicles can also come with a lot of “moving parts,” and a plethora of fine print that can render them difficult to understand – which in turn can lead to some misconceptions about how they work.

One common perception about annuities is that they are riddled with penalties and other restrictions on withdrawals. Therefore, some people avoid these financial vehicles for fear that they won’t be able to access funds if they are needed for an emergency.

However, this is not necessarily the case. In fact, compared to many other commonly used financial vehicles like mutual funds, annuities can actually be less restrictive when it comes to accessing your money – even in the early years of the contract.

Unfortunately, many investors and retirees miss out on the growth, protection and income benefits that fixed and fixed index annuities can provide for them. So, before saying no to an annuity, it is important to have a good understanding of how these products operate, and how they compare to other financial alternatives that you may be considering – because annuities are more liquid than you might think they are.

How much of your money can you withdraw from an annuity?

Depending on the type of annuity you have, there may be an account value from which cash can be withdrawn – even before the annuity is converted over to an income stream (i.e., before it is “annuitized”).

For example, there are two broad categories of annuities. These are immediate and deferred. With an immediate annuity, there is typically just one single lump sum contribution made. The annuity will then begin to make regular income payments to the annuitant (i.e., the income recipient). These payments will generally start within 12 months of purchasing the annuity.

Alternatively, deferred annuities don’t begin paying out income until a time in the future – if ever. One or more contributions may be made into a deferred annuity, during which time the funds in the account grow on a tax-deferred basis. This means that there is no tax due on the gain until the time of withdrawal. Therefore, this money can grow and compound exponentially over time – especially as compared to a taxable investment (with all other factors being equal).

The funds that are inside of a deferred annuity can typically be withdrawn at any time. With some types of annuity withdrawals, you could incur taxes and/or penalties. But this is not necessarily always the case.

So, knowing how and when you may access funds from an annuity could provide you with more – and in some instances, much more – net spendable cash to use for emergencies, as well as health and medical situations, or various other needs.

Do annuities charge higher fees on withdrawals vs. other investments?

Based on the type of annuity you have, as well as the amount of time that has passed since you purchased the annuity, you could incur taxes and/or other withdrawal charges, such as:

  • Surrender charge(s)
  • IRS “early withdrawal” penalty

Taxes on annuity withdrawals

The previously untaxed portion of annuity withdrawals will typically become taxable to you as ordinary income at the time these funds are accessed. In some cases, 100% of the withdrawal may be subject to tax, while in others only a portion will be taxable.

As an example, if you initially purchase an annuity with after-tax money, a portion of each income payment will be considered a return of your contribution (at least until the full amount of your deposits has been repaid). So, this money is not taxable upon withdrawal.

However, the portion of each payment from an annuity that is considered gain will be 100% taxable at your then-current income tax rate. The exclusion ratio is what determines the taxable and non-taxable portion of each of your annuity payments.

If you purchase an annuity using money that has not yet been taxed – such as by rolling over funds from a traditional IRA or 401(k) plan where the contributions went in on a pre-tax basis – then 100% of the annuity payments and withdrawals will be subject to tax.

Annuity surrender penalties

Depending on how long you have held an annuity, it is also possible that you could owe a surrender charge if you make a withdrawal. But many other insurance and investment products – such as CDs, bonds and life insurance – will also penalize you if you cancel or take out “too much” money, particularly during the initial years.

As it pertains to annuities, you may be allowed to access up to 10% of the contract value each year without being hit with a surrender charge – even during the annuity’s surrender charge period.

A piggie bank with a lock around it.

However, if you withdraw more than the annual maximum penalty-free amount, a charge will be incurred. In most cases, the amount of the surrender charge will decrease over time, until it eventually disappears altogether.

With that in mind, it is important to be familiar with both the length and the amount of the surrender penalty before you purchase an annuity, because in some instances, the surrender period could last for 10 or more years.

IRS early withdrawal charge

In addition to taxes and/or a surrender penalty, if you are under the age of 59½ when you withdraw money from an annuity, you could also incur an additional 10% “early withdrawal” penalty from the Internal Revenue Service.

Because of the various taxes and charges that you may be subject to, it is typically recommended that the funds you contribute to annuity won’t be needed in the near future for an emergency or other financial need. However, the same could also be said about other financial vehicles that may charge you with an early withdrawal and/or other type of penalties (and/or taxes) if or when you access funds.

Just some of the investments that typically charge early withdrawal penalties include the following:

  • CDs (certificates of deposit)
  • Bonds
  • Mutual funds

CDs (certificates of deposit)

The early withdrawal penalty on a CD generally consists of interest earned in the investment over a certain period of time, such as several months or possibly even a year.

The exact amount of a CD withdrawal penalty can vary, based on the bank or financial institution where the investment was purchased, as well as on the length of the CD’s term (i.e., the time before its maturity). In this case, the longer the term of the CD, the larger the penalty will usually be. In addition, the earlier money is withdrawn from a certificate of deposit, the less interest you will earn.


Bonds are typically considered to be more conservative than stocks because the former will guarantee the return of your original principal at the time of maturity. However, if you cash in a bond prior to its maturity date, you could forgo some of your earnings, as well as possibly reduce the amount of principal that you receive back.

For instance, selling a bond early negates the guaranteed return of your original investment. Interest rates and other economic factors can impact the price of a bond, too. Therefore, a bond that is sold early (i.e., before its maturity date) will only obtain the price that is available in the market at that time.

In addition, many bonds will make interest payments to their investors twice per year until maturity. So, by selling a bond before it matures, you will also give up the right to receive the interest payments from it.

Mutual funds

Many investors and retirees include mutual funds in their overall asset mix. These financial vehicles can allow you to own a large portfolio of stocks, bonds and other investments without having to purchase each holding separately. This, in turn, can provide you with an affordable method of diversification.

Mutual funds usually charge sales commissions (which go toward compensating the financial adviser who sold you the investment) and other fees to investors. If a sales commission is paid up-front, it can immediately reduce the amount of money that goes into the investment – essentially causing an immediate loss in value.

As an example, if you contributed $10,000 to a mutual fund, and the fund charged a 5% up-front sales commission, you would immediately “lose” $500, and only be left with $9,500 in the account on the very first day.

If a mutual fund has a back-end sales commission (which is also often referred to as a back-end load), all of your contribution would go to work for you right away. But, if you withdrew some or all of your money within a certain period of time, you would be charged at that time.

Similar to an annuity’s surrender charge, the amount of the back-end load on a mutual fund will typically decrease over time until it eventually disappears. However, there may also be mutual fund operating expenses that are passed along to investors on an annual basis.

These can include legal fees, marketing fees, accounting fees and the cost of paying the fund manager(s). Oftentimes, the ongoing fees are higher on mutual funds with back-end loads as versus those with front-end commissions. In any case, though, over time, these yearly fees can add up, and in turn can cause the return on a mutual fund to be significantly less.

How to access funds penalty-free from annuities

When purchasing a deferred annuity, you may have several options for making contributions to it. These will typically include contributing one single lump sum (which may be taken from personal savings or “rolled over” from a retirement account) or making more than one deposit over time.

Because the funds in an annuity grow tax-deferred, it is possible to build up a substantial amount of money in the account – especially over a long period of time. So, what happens if you incur an emergency or other financial situation, and you have to access funds from the annuity?

Contrary to what many people believe, you may be able to access these funds without incurring a penalty – even if the annuity is still within its surrender period. In fact, with many of today’s annuities, the account value may actually be 100% liquid – without penalty – if the funds are needed for various purposes like nursing home expenses and/or costs that are related to a terminal-illness diagnosis.

With longer life expectancy today, more people are concerned about the need for – as well as the cost of – health care and long-term care services. So, over the past decade or so, many insurance companies have begun to offer “crisis” waivers on their annuities. These contract provisions create an “escape hatch” of sorts in the event that the annuity owner needs access to their money sooner than they had initially planned.

For instance, if you have an annuity and you are diagnosed with a qualifying terminal illness, you may be allowed to access some – or possibly even all – of the funds that are in the annuity contract without penalty.

Likewise, if you must reside in a nursing home facility for at least a preset period of time (typically for 90 days or longer), the surrender penalties will also be waived if you withdraw funds from the annuity.

In addition to waiving the surrender penalty for health care and/or long-term care expense needs, other types of annuity crisis waiversc could be used in the event of:

  • Death (of the annuity owner or annuitant)
  • Hospitalization
  • Disability
  • Unemployment

This is not the case with mutual funds, bonds, CDs or most other investments where funds may still be accessed for health care or long-term care costs, but you will still incur a penalty and/or other type of loss upon withdrawal.

As an added bonus, annuities can be converted to an ongoing income stream that will continue to pay out for a pre-set period of time, such as 10 or 20 years, or even for the remainder of your lifetime – no matter what happens in the stock market or interest rates going forward.

In fact, many annuities offer a joint and survivor income option where the income stream will continue through the death of the second individual. Oftentimes, spouses or partners will choose this income alternative in order to ensure that both can rely on a steady stream of incoming cash flow for life.

It may also be possible to withdraw up to 10% of the contract value without penalty – even after converting an annuity over to an income stream. So, in many ways, annuities can be even more liquid than other financial vehicles like mutual funds, stocks, CDs and bonds.

What items should you consider before buying an annuity?

Even though annuities can offer some enticing benefits – both before and after retirement – these financial vehicles are not right for everyone. In addition, not all annuities are exactly the same. Therefore, it is recommended that you consider several important factors before you commit to purchasing an annuity.

These include the following:

  • Savings and investment objectives
  • Need for retirement income/other retirement income generators
  • Risk tolerance
  • Time frame until retirement
  • Taxes and/or penalties on withdrawals
  • Health/medical history
  • Other methods you have in place for paying possible “crisis” expenses (such as long-term care or disability insurance policies)

Is an annuity right for you?

If it seems like an annuity might be a good addition to your portfolio and/or if you would like to learn more about these flexible financial vehicles, talking over your short- and long-term objectives with a retirement income specialist can be beneficial.

At Alliance America, we specialize in helping people reach their retirement savings and income goals. We take a look at your whole financial picture, as versus just small pieces of it, so we can guide you from where you are now financially to where you want to be in the future.

Alliance America can help

Alliance America is an insurance and financial services company dedicated to the art of personal financial planning. Our financial professionals can assist you in maximizing your retirement resources and achieving your future goals. We have access to an array of products and services, all focused on helping you enjoy the retirement lifestyle you want and deserve. You can request a no-cost, no-obligation consultation by calling 888-864-2542 today.

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