How to Cash Out An Annuity: Step-by-Step Guide

Quick answer

• Understand your annuity contract terms thoroughly before considering a cash-out.
• Determine your financial goal for cashing out and your timeline.
• Calculate the potential surrender charges and taxes you might owe.
• Explore all your options, including partial withdrawals, annuitization, or selling to a third party.
• Consult with a financial advisor and tax professional to understand the implications.
• Compare quotes if considering selling your annuity.

Who this is for

• Individuals who own an annuity and need access to its funds for unexpected expenses or life events.
• Those who have an annuity that is no longer meeting their financial goals or risk tolerance.
• Retirees or pre-retirees looking to supplement their income or manage their assets more effectively.

What to check first (before you act)

Goal and timeline

Before you can decide if cashing out an annuity is the right move, you need to be crystal clear on why you’re considering it and when you need the money. Are you facing a sudden medical bill, planning a major purchase, or simply want to consolidate your assets? Your timeline will significantly influence your options and the potential costs involved.

Current cash flow

Review your current income and expenses to understand your overall financial picture. This will help you determine how much of your annuity’s value you actually need and how the lump sum will fit into your broader financial plan. A detailed understanding of your cash flow will prevent you from making a hasty decision that could jeopardize your long-term financial stability.

Emergency fund or safety buffer

Do you have a readily accessible emergency fund? Cashing out an annuity, especially if it incurs penalties, should ideally be a last resort if you have other liquid assets available. Ensure you have enough saved to cover 3-6 months of living expenses before tapping into long-term investments like annuities.

Debt and interest rates

Assess your outstanding debts. If you have high-interest debt (like credit cards), using annuity funds to pay it off might be a financially sound decision, potentially yielding a better “return” than keeping the annuity. However, compare the interest rate on your debt to the guaranteed growth rate of your annuity and any penalties for early withdrawal.

Credit impact

While cashing out an annuity itself doesn’t directly impact your credit score, how you manage the funds afterward can. If you use the cash to pay off debts, it could improve your credit utilization. Conversely, if you incur significant penalties and taxes that strain your finances, it could indirectly affect your ability to manage credit responsibly in the future.

Step-by-step (simple workflow)

1. Review your annuity contract

What to do: Locate your annuity contract documents. Read through them carefully, paying close attention to sections on surrender charges, withdrawal penalties, death benefits, and any riders you may have.
What “good” looks like: You have a clear understanding of the contract’s terms, including the surrender charge schedule and any fees associated with withdrawals.
Common mistake and how to avoid it: Not reading the fine print. Many people assume they know their contract details. Avoid this by setting aside dedicated time to read every page, or even better, have a professional review it with you.

2. Identify your financial goal

What to do: Clearly define why you need to access these funds and your intended use for them. Is it for retirement income, an emergency, or to pay off debt?
What “good” looks like: You have a specific, measurable, achievable, relevant, and time-bound (SMART) goal for the money.
Common mistake and how to avoid it: Cashing out without a clear purpose. This can lead to impulsive spending and regret. Avoid this by writing down your goal and sticking to it.

3. Determine your timeline

What to do: Establish when you need access to the funds. Is it immediate, within a few months, or a year from now?
What “good” looks like: You have a realistic timeframe that aligns with your financial goal and the annuity’s withdrawal provisions.
Common mistake and how to avoid it: Underestimating the time it takes to process withdrawals or sell an annuity. Avoid this by starting the process well in advance of when you need the money.

4. Calculate surrender charges and penalties

What to do: Refer to your contract for the surrender charge schedule. These charges typically decrease over time. Also, check for any other early withdrawal penalties imposed by the insurance company.
What “good” looks like: You have a precise figure for the surrender charges you would incur based on your withdrawal amount and the age of the annuity.
Common mistake and how to avoid it: Assuming surrender charges are fixed. They often decrease annually. Avoid this by consulting the surrender charge schedule in your contract.

5. Estimate potential taxes

What to do: Understand that earnings within an annuity are typically taxed as ordinary income when withdrawn. If you’re under 59 ½, you may also face a 10% federal tax penalty on the earnings. Consult a tax professional for personalized advice.
What “good” looks like: You have a solid estimate of your tax liability, including any potential penalties.
Common mistake and how to avoid it: Forgetting about taxes and penalties. These can significantly reduce the net amount you receive. Avoid this by factoring them into your calculations from the start.

6. Explore withdrawal options

What to do: Investigate your options: a full lump-sum withdrawal, partial withdrawals, or annuitizing the contract (converting it into a stream of income).
What “good” looks like: You understand the pros and cons of each option in relation to your goal and financial situation.
Common mistake and how to avoid it: Only considering a full lump-sum withdrawal. Partial withdrawals can sometimes offer more flexibility with fewer penalties. Avoid this by exploring all available withdrawal methods.

7. Consider selling your annuity

What to do: For some, selling their annuity to a third-party settlement company might be an option. This usually involves receiving a lump sum payment that is less than the annuity’s face value but avoids surrender charges and taxes on earnings. Research reputable buyers and compare offers.
What “good” looks like: You’ve received and compared multiple offers from licensed and reputable settlement companies.
Common mistake and how to avoid it: Not comparing offers or dealing with an unreputable buyer. This can lead to a significantly lower payout or even a scam. Avoid this by getting quotes from several established companies.

8. Consult with professionals

What to do: Speak with a fee-only financial advisor and a tax professional (like a CPA). They can help you analyze your situation, understand the implications, and make an informed decision.
What “good” looks like: You have received objective advice tailored to your specific financial circumstances.
Common mistake and how to avoid it: Relying solely on the annuity provider’s advice. They represent the insurance company, not you. Avoid this by seeking independent professional counsel.

9. Initiate the process

What to do: Once you’ve made a decision, contact your insurance company to begin the withdrawal or sale process. Be prepared to provide documentation.
What “good” looks like: The process is initiated smoothly with all necessary paperwork submitted correctly.
Common mistake and how to avoid it: Providing incomplete or inaccurate information. This can cause significant delays. Avoid this by double-checking all forms before submitting them.

10. Receive and manage funds

What to do: Once approved, you will receive the funds. Immediately deposit them into a secure account and manage them according to your financial plan.
What “good” looks like: The funds are received promptly and are securely managed according to your pre-defined goals.
Common mistake and how to avoid it: Not having a plan for the funds after they are received. This can lead to overspending or poor investment choices. Avoid this by having a clear plan for the money before it arrives.

Common mistakes (and what happens if you ignore them)

| Mistake | What it causes