A surrender charge is a fee incurred when you sell, cash in, or cancel certain types of investments, insurance policies, or annuities. It is imposed during a pre-set number of years known as a surrender period. After the surrender period ends, the surrender charge goes away.
Learn what types of investments have surrender charges and how to avoid them.
What Is a Surrender Charge?
Surrender charges are fees imposed on investments, annuities, and life insurance policies. They are imposed for a pre-set number of years to allow the issuing company to recoup the cost of offering you the product. If you sell, cash in, or cancel your investment early, you will have to pay a surrender charge.
After the surrender period ends, the issuing company will no longer assess a surrender charge when you close out your investment.
Fees for backing out of a financial contract early are most common with:
- Deferred annuities (such as fixed, variable, and index annuities)
- Whole life insurance
- Class-B mutual funds
Term life insurance, which has no cash value, is generally not subject to surrender charges. Similarly, immediate annuities, which are designed to provide immediate income, aren't subject to fees for short-term withdrawal.
Alternate names: contingent deferred sales charges, a back-end load
How Does a Surrender Charge Work?
Surrender charges are assessed as fees when you cash out these investments early. You will receive the amount that you cash out minus the surrender charge.
The surrender period on these products is typically six to eight years. After that point, you no longer have to pay a surrender charge. Some companies may waive surrender charges if the interest being offered on the contract falls below a certain level.
Companies that sell financial products pass along these costs to customers for a few reasons:
- Offset operating cost: Companies recoup their administrative, operational, and sales costs by charging regular fees, but they lose these fees if you give up the product too quickly.
- Deter short-term use: Investments and other products are designed for long-term financial goals, such as retirement, rather than short-term purposes, such as cash for an emergency expense.
- Maximize returns: Companies want to be able to invest your money over the long term in order to yield higher returns.
There are three main ways to forgo these fees.
Hold Past the Surrender Period
Surrender charges are only imposed if you give up the product before the surrender period, which means that you can avoid the fee by holding it past that period. You can usually identify the surrender period in the surrender fee schedule listed in the prospectus or contract of the product when you first buy it.
The period can vary from as short as 30 days for mutual funds to 10 years or more years for annuity and insurance products.
Withdraw a Smaller Amount
Most annuity contracts have a free withdrawal provision that lets you take out a certain percentage of the contract value, such as 10%, every year without incurring a surrender charge.
Take Advantage of Fee Waivers
The issuing company may waive surrender charges in certain conditions, such as when:
- A survivor collects death benefits from an annuity
- A retiree takes required minimum distributions
Read the terms of the contract for the specific product to identify the circumstances and the associated steps to take to get the fees waived.
If you must cash in your insurance policy or annuity, double check when surrender charges expire. If you are close to that date, it is better to delay a few days or weeks to avoid the surrender charges.
How Much Do Surrender Charges Cost?
The fees vary by the product, issuing company, and the period you own the product.
The typical surrender fee schedule starts at a percentage of the withdrawal amount in the first year you own them and gradually decreases by 1% with each successive year you own the product. Eventually, it is eliminated entirely.
For example, you might be charged a 7% surrender fee if you withdraw funds from an annuity in year one, a 1% fee on withdrawals in year seven, and no surrender fee during or after year eight. On a $10,000 withdrawal, you would pay $700 in year one versus only $100 in year seven; you would be rewarded for your patience with a savings of $600.
In general, the shorter the holding period, the higher the surrender fee.
The cost of surrender charges may be regulated by the state where you purchase your investment. For example, Idaho law prohibits surrender periods for contracts issued in the state from lasting longer than ten years or exceeding 10% in the first year.
Do I Need Investments with Surrender Charges?
As a general rule of thumb, surrender charges reduce the value of and the overall return on your investment.
However, high-quality annuities, life insurance policies, and mutual funds that carry surrender charges may still be worthwhile if you have a long investment time horizon and are willing to give up liquidity during the surrender period. A free-withdrawal period also can make a product with a surrender charge a more flexible investment choice.
If you have a short investment horizon and need high liquidity, you may want to stay away from products that impose a surrender charge.
If you're not sure about which financial product is right for you, work with a fee-only financial planner. They aren't compensated for the sale of investment or insurance products, so you can be confident they are recommending products that are in your best interest.
When choosing an investment or annuity product with a surrender charge, make sure the benefits, such as the potential for income or long-term capital appreciation, outweigh the lack of liquidity.
Similarly, if you are considering a life insurance product with a surrender charge, know that you will need to own it and pay premiums for a long time for this purchase to work to your long-term benefit. Be sure you have the ability to pay the premiums even if you were to suffer a job loss or other change in your financial situation.
- A surrender charge is a fee incurred when you sell, cash in, or cancel certain types of investments during a pre-set number of years known as a surrender period.
- After the surrender period ends, the surrender charge goes away.
- These charges are most common with deferred annuities, whole life insurance, and Class-B mutual funds.
- If you purchase a financial product with a surrender charge, you should plan to hold it long-term to avoid paying these fees.