How Does a 10-Year Annuity Work: Payouts, Taxes & Surrender Charges

A 10-year annuity is an insurance contract organized around a decade, and the phrase points to one of two very different products. In a period certain payout, the insurer converts your deposit into 120 guaranteed monthly checks. In a deferred annuity with a 10-year surrender schedule, your money grows inside the contract and a declining penalty applies if you pull more than the allowed amount out during those ten years. How much you receive, when you can touch the balance, and what the IRS takes all follow from which version you have.

The 10-Year Period Certain Payout

Choose a period certain payout and the insurer divides your account balance into 120 monthly payments. Each check blends a return of your original deposit with interest earned on the balance still sitting with the insurer, similar to a mortgage in reverse. Every payment is guaranteed regardless of market swings or your health during the decade.

A $100,000 deposit crediting 5% annually would produce roughly $1,061 per month for 120 months, or about $127,300 in total payments. Early checks carry more interest; later ones draw more from principal. After the 120th payment the contract ends and the insurer owes you nothing further.

This structure fits people who need reliable income over a defined stretch, such as bridging early retirement and Social Security, without worrying about outliving the payments or having them reduced.

The 10-Year Surrender Charge Schedule

A deferred annuity uses “10-year” in a different sense: the window during which the insurer charges a percentage fee if you withdraw more than the contract’s annual free-withdrawal allowance, which is often 10% of your account value per year. The fees offset the sales commissions and administrative costs the insurer fronted at issue.

Charges usually start high and step down each year. A common 10-year schedule:

Year 1: 10% on excess withdrawals
Year 2: 9%
Year 3: 8%
Year 4: 7%
Year 5: 6%
Year 6: 5%
Year 7: 4%
Year 8: 3%
Year 9: 2%
Year 10: 1%

After year 10 the charges disappear and you can take your full balance without penalty from the insurer. Shorter surrender periods of five to seven years exist and typically pair with lower credited interest rates. Longer surrender periods usually credit higher rates because the insurer can invest your money over a longer horizon.

How the Payments Are Taxed

If you bought the annuity with after-tax dollars outside an IRA or employer plan, the IRS treats each payment as part taxable interest and part tax-free return of your deposit. The split comes from an exclusion ratio: your total investment divided by the total expected return over the life of the contract.¹

Using the $100,000 deposit with $127,300 in expected payments, the exclusion ratio is about 78.6%. Roughly $834 of each $1,061 monthly check comes back tax-free as recovered principal, and about $227 is taxable as ordinary income.² Once you have recovered your entire original investment through those tax-free portions, every dollar of every remaining payment becomes fully taxable.¹

If the annuity sits inside a traditional IRA, SEP IRA, or similar pre-tax retirement account, the entire payout is taxed as ordinary income when you receive it. There is no exclusion ratio because the money was never taxed going in. Roth IRA annuities held for at least five years pay out completely tax-free once you are over 59½.³

One coordination point for qualified accounts: required minimum distributions generally begin by April 1 of the year after you turn 73.⁴ If your annuity’s scheduled payments meet or exceed the RMD amount each year, no separate withdrawal is needed. If they fall short, you will need to take extra from the IRA to make up the difference.

Getting Money Out Early

Withdrawing earnings before age 59½ triggers a 10% federal penalty on top of the regular income tax. The penalty comes from Section 72(q) for non-qualified annuities² and Section 72(t) for annuities held inside an IRA or employer plan.⁵ The insurer’s surrender charge, if applicable, is separate and stacks on top.

Both sections waive the 10% penalty in several cases:

You are 59½ or older.
The distribution is paid to a beneficiary after the owner’s death.
You become totally and permanently disabled.
You take substantially equal periodic payments based on your life expectancy for at least five years or until you reach 59½, whichever comes later.

Non-qualified contracts add exceptions for distributions from an immediate annuity and for amounts tied to investment made before August 14, 1982.² IRA-held annuities carry a broader list, including unreimbursed medical expenses exceeding 7.5% of adjusted gross income, qualified higher education expenses, up to $10,000 for a first-time home purchase, health insurance premiums while unemployed, qualified birth or adoption expenses of up to $5,000 per child, and certain distributions to military reservists called to active duty.⁵

If You Die Before the 10 Years Are Up

For a period certain payout, the insurer does not keep the unpaid balance. Your named beneficiary receives the remaining scheduled payments. Die after 70 monthly checks and your beneficiary collects the other 50.

For a deferred annuity still in the surrender period, the contract’s death benefit governs. Most contracts guarantee at least the return of your original deposit or the current account value, whichever is greater. Some include enhanced riders that lock in the highest anniversary value the account ever reached.

A surviving spouse can generally continue the contract instead of cashing out, stepping in as owner and keeping the tax-deferred growth or the scheduled payments running. The original exclusion ratio carries over to the spouse’s payments.¹

A separate 10-year clock applies to annuities held inside IRAs or employer plans when the owner died in 2020 or later. Most non-spouse beneficiaries must empty the inherited account by the end of the tenth year after the year of death, though eligible designated beneficiaries (surviving spouses, minor children, disabled or chronically ill people, and beneficiaries no more than 10 years younger than the deceased) can still stretch distributions over their own life expectancy.⁶

What Inflation Does to a Fixed Payment

A check that feels comfortable in year one buys less in year ten. At 3% average annual inflation, a $1,000 monthly payment retains about $744 in purchasing power by the end of the decade, a 26% decline. At 5% inflation, the erosion is closer to 39%.

Some insurers offer cost-of-living adjustment riders that raise each year’s payment by a set percentage. The tradeoff is a lower starting check, because the insurer funds the annual increases by reducing the initial amount. Over a 10-year period the erosion is meaningful but far less severe than it would be across a 20- or 30-year retirement stream.

Switching Contracts Without a Tax Bill

If you are unhappy with your contract’s rate, fees, or features, federal law lets you move directly into another annuity without triggering a taxable event, provided the funds transfer between insurance companies and you never take personal possession of the money.⁷ You can also exchange an annuity for a qualified long-term care insurance contract under the same rule. The owner must be the same person on both contracts.⁸ Partial exchanges are allowed as well, as long as the insurer moves the funds directly.

Before you start, check where you stand in the current contract’s surrender schedule. In year four of a 10-year schedule, the transferred amount could carry a 7% charge. The new contract will typically start its own surrender clock from zero, potentially locking your funds for another decade. Those two costs need to clear before the switch is worth it.

1
Internal Revenue Service. Publication 939, General Rule for Pensions and Annuities
2
Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts
3
Internal Revenue Service. Topic No. 451, Individual Retirement Arrangements (IRAs)
4
Internal Revenue Service. Retirement Topics – Required Minimum Distributions (RMDs)
5
Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
6
Internal Revenue Service. Retirement Topics – Beneficiary
7
Office of the Law Revision Counsel. 26 USC 1035 – Certain Exchanges of Insurance Policies
8
Internal Revenue Service. Revenue Ruling 2003-76, Section 1035 Exchanges of Insurance Policies