How to Withdraw Money From an Annuity: Taxes, Penalties, and Fees

To withdraw money from an annuity, you choose a distribution method your contract allows, send the insurer a completed withdrawal request, and settle up on surrender charges and taxes. The tax hit depends on whether the annuity was funded with pre-tax or after-tax dollars, and a distribution taken before age 59½ carries a 10% federal penalty on top of ordinary income tax. Getting the order right matters. Getting it wrong means surrender fees, an unexpected tax bill, or both.

Pick a Distribution Method

Your contract defines several ways to access the money, each with different trade-offs between flexibility and long-term income.

Partial withdrawal. You pull out a specific dollar amount and leave the rest invested. Most contracts allow up to 10% of the account value per year without a surrender charge; anything above that threshold triggers a penalty on the excess.
Systematic withdrawals. You schedule regular payments of a fixed amount or percentage over a set period. The contract stays active, but the balance shrinks with each payment and can eventually reach zero.
Full surrender. You cash out the entire contract. The insurer pays the account value minus any surrender charges and outstanding loans, the contract ends, and all guarantees end with it.
Annuitization. You convert the balance into guaranteed periodic payments for a fixed number of years or for life. This is usually irreversible: you give up access to the lump sum in exchange for a predictable income stream.

Annuitization is a separate decision from a withdrawal and worth sitting with before you sign anything. A life-contingent payout continues as long as you’re alive. A period-certain payout runs for a set number of years, and if you die before it ends, your beneficiary collects the remaining payments. Some contracts combine both.

Surrender Charges and the 10% Free Withdrawal

Surrender charges are the insurer’s way of recovering commissions and expenses it paid when you bought the annuity. Take out more than the penalty-free amount during the surrender period and the insurer deducts a percentage of the excess. A typical schedule starts near 7% in the first year and drops by roughly one percentage point annually until it reaches zero, usually after six to eight years. Your specific schedule is in the original contract, and it’s worth pulling before you request anything.

Most contracts include a free withdrawal provision that lets you take up to 10% of the account value each year with no surrender charge. This is the single most useful feature if you need liquidity but aren’t ready to cash out. Anything beyond the 10% threshold gets hit with the full surrender charge on the excess.

Some contracts also waive surrender charges under specific circumstances. Nursing home confinement is the most common trigger: if the owner is confined to a facility for a minimum number of consecutive days (the threshold varies by contract), the charge is waived. Terminal illness and disability waivers exist in some contracts as well. These waivers have strict notice and documentation requirements, so read the rider language before assuming you qualify.

If your annuity includes a market value adjustment, the amount you receive on surrender can be higher or lower than your account value depending on how interest rates have moved since you bought the contract. Rising rates work against you; falling rates work in your favor. Market value adjustments apply on top of any surrender charges, so the net payout is harder to predict without running the numbers.

Submit the Withdrawal Request

The process starts with the insurer’s withdrawal request form, available through its website or customer service line. You’ll need your contract number (on your policy documents or annual statements), your Social Security number, and your banking details if you want an electronic transfer. The form also asks you to make elections on federal and state tax withholding, which matter more than most people realize.

Federal law requires the insurer to withhold income tax from your distribution unless you specifically opt out. For a lump-sum or one-time withdrawal, the default withholding is 10% of the taxable portion if you don’t submit a completed Form W-4R. For periodic payments, withholding follows a schedule based on your filing status unless you submit Form W-4P with different instructions.¹ Choosing the right rate now prevents either a surprise tax bill or an unnecessary interest-free loan to the government.

Submit the completed form through the insurer’s online portal, by fax, or by certified mail. Certified mail gives you a tracking number and proof of delivery, worth the small extra cost for a retirement transaction. The insurer will verify your identity by matching the signature against the one on file. Expect review and processing to take roughly five to ten business days. Electronic transfers after approval typically arrive within two to three business days; paper checks can take up to two weeks. Some insurers require a notarized signature for large withdrawals or full surrenders.

Taxes on a Non-Qualified Annuity Withdrawal

A non-qualified annuity is one you bought with after-tax dollars outside a retirement plan. Because you already paid tax on the money going in, only the earnings portion of each withdrawal is taxable. The catch: the IRS forces you to withdraw earnings first.

Under Section 72(e) of the Internal Revenue Code, any amount you take out before annuitizing comes from earnings until all the gains are exhausted, and only then do you reach your original investment, which comes out tax-free.² The taxable portion of a withdrawal equals the lesser of the amount you’re taking out or the difference between the contract’s current cash value and your total investment.¹ Early withdrawals from a non-qualified annuity are heavily taxed until you’ve pulled out all the gains.

Those earnings are taxed at ordinary income rates, currently 10% to 37% depending on your total taxable income. Annuity gains never qualify for the lower long-term capital gains rates. That difference can be substantial for people in higher brackets.

Taxes on a Qualified Annuity Withdrawal

A qualified annuity lives inside a tax-advantaged account like a traditional IRA, 401(k), or 403(b). Contributions went in pre-tax or were deducted from your taxable income, and the IRS has never collected on that money. Every dollar you withdraw is fully taxable as ordinary income.¹ No exclusion ratio, no tax-free portion, no earnings-first ordering. A $50,000 withdrawal adds $50,000 to your taxable income for the year.

Timing matters. A large withdrawal in a single year can push you into a higher bracket, while spreading distributions across several years may keep your effective rate lower. Retirees who hold both qualified and non-qualified annuities often pull strategically from each to manage their annual tax exposure.

The 10% Early Withdrawal Penalty

Take money from an annuity before age 59½ and the IRS adds a 10% penalty on the taxable portion, on top of the ordinary income tax you already owe. For non-qualified annuities, the penalty hits the earnings portion. For qualified annuities, it applies to the entire withdrawal.²

Several exceptions eliminate the penalty even under 59½:

Death of the contract holder. Distributions to beneficiaries after the owner’s death are penalty-free.
Disability, as defined by the tax code.
Substantially equal periodic payments (SEPP). You commit to a fixed series of payments based on your life expectancy for at least five years or until you reach 59½, whichever comes later. The IRS allows three calculation methods: required minimum distribution, fixed amortization, and fixed annuitization.³
Immediate annuity contracts. If the annuity begins payments within a year of purchase, distributions are exempt.
Any portion of a withdrawal allocable to your investment before August 14, 1982.

SEPP is the most commonly used workaround, but it demands discipline. Modify the payment schedule before the later of five years or age 59½ and the IRS retroactively applies the 10% penalty to every distribution you received under the arrangement, plus interest.³ The recapture tax can be brutal.

Required Minimum Distributions on Qualified Annuities

Qualified annuities are subject to required minimum distribution rules, just like IRAs and 401(k) accounts. You must begin taking annual withdrawals by April 1 of the year after you turn 73.⁴ Under the SECURE 2.0 Act, that starting age rises to 75 for individuals who turn 73 after December 31, 2032.⁵

Miss an RMD and the penalty is steep: a 25% excise tax on the amount you should have withdrawn but didn’t. Catch it and correct it within two years and the penalty drops to 10%.⁴ For an annuitized contract, the periodic payments usually satisfy the RMD as long as they meet or exceed the minimum. For a deferred qualified annuity you haven’t annuitized, you have to calculate and withdraw the RMD each year or face the excise tax.

Non-qualified annuities are not subject to RMD rules during the owner’s lifetime. Because you funded them with after-tax dollars outside a retirement plan, the IRS doesn’t force distributions on any schedule.

Switching Contracts Without Tax: The 1035 Exchange

If you’re unhappy with your current annuity’s fees, performance, or features but don’t actually need the cash, a 1035 exchange transfers the funds directly into a new annuity contract without triggering tax. Under Section 1035 of the Internal Revenue Code, no gain or loss is recognized when you exchange one annuity for another, or when you exchange an annuity for a qualified long-term care insurance contract.⁶

Two requirements: the owner and annuitant on the new contract must match the old one, and the transfer must go directly between insurance companies. If the money passes through your hands first, the IRS treats it as a distribution and you owe tax on the gains. A 1035 exchange also doesn’t reset the surrender clock on the old contract, so check whether your current insurer will still charge a surrender fee on the transfer. The new contract will have its own surrender schedule starting from day one.

Federal Tax Withholding

The insurer must withhold income tax from your distribution unless you affirmatively elect out. For periodic payments like monthly annuity income, withholding follows Form W-4P based on your filing status and adjustments. For non-periodic distributions like a partial withdrawal or full surrender, the default is 10% of the taxable amount if you don’t submit a Form W-4R.⁷

Withholding isn’t a separate tax. It’s a prepayment toward your annual income tax bill. If too little was withheld, you’ll owe the difference at filing and may face an underpayment penalty. If too much was withheld, you’ll get a refund. People taking large distributions often benefit from increasing withholding above the default or making estimated quarterly payments to avoid underpayment penalties. State withholding rules vary and are separate from the federal requirements.

1
Internal Revenue Service. Publication 575 (2025), Pension and Annuity Income
2
Office of the Law Revision Counsel. 26 USC 72 – Annuities, Certain Proceeds of Endowment and Life Insurance Contracts
3
Internal Revenue Service. Substantially Equal Periodic Payments
4
Internal Revenue Service. Retirement Plan and IRA Required Minimum Distributions FAQs
5
Congress.gov. Required Minimum Distribution (RMD) Rules for Original Owners
6
Office of the Law Revision Counsel. 26 USC 1035 – Certain Exchanges of Insurance Policies
7
Federal Register. Withholding on Certain Distributions Under Section 3405(a) and (b)