A surrender charge is a fee incurred when you sell, cash in, or cancel certain types of investments, insurance policies, or annuities. It can be 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.
- Firms that sell certain types of investment products that mature will charge a fee if you decide to surrender or cancel your investment too early.
- Surrender charges are only applied during a pre-set term, after which they go away.
- These charges are most common with deferred annuities, whole life insurance, and Class-B mutual funds.
- If you purchase a product with a surrender charge, you should plan to hold it long-term to avoid paying these fees.
What Is a Surrender Charge?
Surrender charges are fees imposed on investments, annuities, and life insurance policies. The reason behind these charges is that firms who sell these products use the funds to invest, and so it serves their bottom line if the buyers are willing to keep them longer. They are imposed for a pre-set number of years as stated in the contract, to allow the firm who issued the product to recoup the cost of offering it to you. If you sell, cash in, or cancel your investment early, you will have to pay a surrender charge.
After your surrender period ends, the charge no longer applies, and the firm that sold you your product will no longer be able to charge or assign fees if you decide to close it out.
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 not often subject to surrender charges. This makes sense, because the firm loses nothing if you stop service. By the same token, immediate annuities are not subject to fees for short-term withdrawal either, because they are designed to provide income right away.
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 varies but for the most part is between six to eight years. After that point, you no longer have to pay a surrender charge. Some firms may waive these charges if the interest being offered on the contract falls below a certain level.
Why Do Firms Charge for Early Surrender?
Firms that sell financial products pass along these costs to the people who buy their products for a few reasons:
- Offset operating cost: Firms need to recoup their administrative, operational, and sales costs by charging standard 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 for short-term purposes, such as cash for a sudden surprise expense.
- Maximize returns: Firms want to be able to invest your money over the long term in order to gain higher returns.
How Can I Avoid Paying a Surrender Charge?
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 find the precise date of the surrender period on your contract. Look for the fee schedule listed in the 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.
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 paying the charges.
Withdraw a Smaller Amount
Most annuity contracts have a free withdrawal provision that lets you take out a certain percent of the contract value, such as 10%, each year without incurring a surrender charge.
Take Advantage of Fee Waivers
The firm may waive your surrender charge in certain cases, such as when:
- Your spouse has passed away, and you collect survivor death benefits from an annuity.
- You retire and take the required minimum distributions.
These may show up on your contract as "crisis waivers," or they may be in a section about IRS rules. Read the terms of your contract for the exact product to learn the details of this waiver, and what steps you need to take to get the fees waived.
How Much Do Surrender Charges Cost?
The fees vary by the product, issuing firm, and how long you own the product.
A standard surrender fee schedule charge depends on how much you take out. It starts at a percent of this amount in the first year you own the product, and then falls by 1% with each year. After enough time has passed, it is fully gone.
For instance, you might be charged a 7% surrender fee if you withdraw funds from an annuity in year one, a 1% fee on amounts you withdraw in year seven, and no fee at all during or after year eight. Under this scheme, if you want to withdraw $10,000, you would pay $700 in year one versus only $100 in year seven. This means if you are patient you can save $600.
For the most part, the shorter the holding period, the higher the surrender fee.
The cost of surrender charges may depend on the state where you purchase your investment, as each state has its own laws on the matter. For instance, Idaho law does not allow surrender periods for contracts to last longer than ten years, and fee amounts cannot be greater than 10% in the first year.
Do I Need to Invest in Products with Surrender Charges?
As a rule of thumb, surrender charges reduce the value of and the return on your investment.
Fees don't negate their full value though. High quality annuities, life insurance policies, and mutual funds that carry these charges may still be worth the money in some cases. If you have a long investment time horizon and are willing to live with less cash during the surrender period, they might be right for you. Also, if your product has a free withdrawal period, the surrender charge becomes less of an issue.
On the other hand, if you have a shorter time horizon and need the cash on hand, you may want to stay away from products that impose a surrender charge.
If you're not sure about how or whether to invest in a product that has surrender charges, work with a fee-only financial planner. They aren't paid for selling products, so you can be sure that the products they offer are in your best interest.
The Bottom Line
When choosing an investment or annuity product with a surrender charge, make sure the perks outweigh the lack of liquidity. You might look to features such as the potential for income or long-term capital appreciation.
Lastly, if you want to purchase a life insurance product with a surrender charge, know that you will need to own it and pay premiums for a long time before it starts to make gains for you in the long term. Be sure also that you can afford to pay the premiums even if you were to suffer a job loss or other upset.