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I'm 36 and when I left my last job I rolled $100K from my 401K into an Indexed annuity. It has a 4.75% max annual return. If I withdraw it all today, I have to pay an 18.5% surrender fee. This fee decreases to 0% over the next 12 years. I can, however, withdraw up to 10% annually fee free.

I feel that I can get a better rate of return outside this annuity. Should I take all of it out now or gradually over the next few years to avoid surrender fees?

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  • Run the numbers. How confident are you that you'll do how much better, and how many years of that would it take to recover from the cancelation penalty? Remember, the purpose of an annuity is to give you a guaranteed return; moving it elsewhere means giving up that protection. Risk always trades off against reward; to get higher returns you must accept more risk, and only you can decide whst balance between those makes sense for you.
    – keshlam
    Mar 24, 2015 at 2:20
  • If you are still within 30 days of signing the contract, you should ask to terminate the contract. You would just fill out some paperwork at the broker/agent office. If you were misled by the salesperson about the rate cap, you should file a compmaint in writing. They are required to report all written complaints to their compliance office. Annuity sales are highly scrutinized, precisely for this reason.
    – Kent A.
    Mar 24, 2015 at 3:21

2 Answers 2

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Considering the penalty, you might be better off removing only the 10% each year. Don't forget an 18.5% loss requires a 22.7% gain to overcome.

100-18.5 = 81.5 Going from 81.5 to 100 = 22.7% gain needed to break even on a 18.5% loss.

If I need to beat 22.7% + the original 4.75% , then maybe I would only take out 10% per year.

EDIT: Little blurb on possible tax liability of any 'earnings' in addition to your penalty.

Taxation of lump-sum distributions

Taking a lump-sum distribution of your annuity funds can have many consequences. If you make this election within the first few years after purchasing your annuity, you may be subject to surrender charges imposed by the issuer. In any case, the earnings portion of the distribution will be treated as ordinary income in the year you take the distribution. Also, keep in mind that a large lump-sum distribution could actually push you into a higher tax bracket, dramatically increasing your tax liability.

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  • +1 for tax impact warnings! The penalty for early withdrawal could be a great deal worse then the already high 18%+!
    – BrianH
    Mar 24, 2015 at 3:58
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If you withdraw today, you have $81.5k to invest. You need to model how this will do compared to pulling it out 10k at a time over 10 years. Your results will depend on your assumptions of annuity return and market return, as well as taxes (which I'm not going to touch). A very simplistic analysis would be below (with an assumed return in the annuity of 4.5% and market of 7% each and every year, numbers I am making up). Other things to keep in mind: does the annuity have a minimum return? What happens in the case of a down year followed up by up year? Plus, again, this ignores tax impacts because you have not provided enough info to estimate this.

Value after 10 years: Pull it out now: 81500*(1.045)^10 = $126567 Pull it out 10k at a time over 10 years: Year 1: 90000*1.045 + 10000*1.07 (if you wanted to make it more complicated, you could model it month by month and shift the payout from the annuity "pot" to the non-annuity "pot") Year 2: (80000+last years annuity returns-payout)*1.045 + (20000+last years non-annuity returns+payout)*1.07

You can easily do this with Excel. One question I have is the 10% withdrawal, is this of the original value? Is it of the remaining value?

ETA: Plus, don't forget that higher return entails higher risk.

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  • Yup, higher risk. Very likely we will have at least one down year over the next decade. Maybe only withdrawing 10% per year could be considered 'Dollar Cost Averaging' Mar 24, 2015 at 2:34

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