A free withdrawal on an annuity is a contract provision that lets you take out a portion of your account each year without paying the insurance company’s surrender charge. Most contracts cap the allowance at 10 percent of the account value per year, and whatever you don’t use resets rather than rolls over.1Bankrate. Can You Withdraw Money From an Annuity? The provision waives the insurer’s penalty only. Federal income tax on the taxable portion, and a possible 10 percent IRS penalty if you’re under 59½, still apply.
How Much You Can Take Each Year
The standard allowance is up to 10 percent per contract year, though some products set it at 5 percent and others at 15 percent. The figure written into your contract controls.2Nationwide. Understanding Annuity Withdrawals Most contracts open the door after the first contract anniversary, though a handful of products allow access within the first year.1Bankrate. Can You Withdraw Money From an Annuity?
The allowance is non-cumulative. Skipping a withdrawal in year two doesn’t give you 20 percent to work with in year three. Each contract anniversary starts a fresh 10 percent, and anything unused disappears when the year turns.
How the Dollar Amount Is Calculated
Insurers use one of two formulas, and in a growing account the difference can be thousands of dollars.
- Current account value method. The percentage applies to what your account is worth on the day you request the withdrawal. A $130,000 account with a 10 percent allowance gives you up to $13,000.
- Premiums-paid method. The percentage applies to total premiums you’ve contributed, ignoring growth. A $100,000 investment yields only a $10,000 free withdrawal even if the account is now worth $130,000. Prior partial withdrawals reduce the remaining premium basis, so future free amounts shrink further.
The account-value method is more common and more favorable when the market has moved in your favor. Check the specimen contract or prospectus to confirm which formula yours uses.
If You Take More Than the Free Amount
Exceeding the allowance doesn’t retroactively cost you the free portion. The surrender charge applies only to the dollars above the limit. If you’re entitled to $10,000 free and withdraw $15,000, the surrender charge hits the extra $5,000 only.3Thrivent. Annuity Withdrawals: Rules, Taxes and Charges
Contracts with a market value adjustment add a second layer to the excess. An MVA recalculates the value of the amount above your free allowance based on how interest rates have moved since you bought the annuity. Rates up, the MVA reduces your proceeds; rates down, it adds a small credit. Staying within the free withdrawal amount avoids the MVA entirely.
Taxes and the Under-59½ Penalty Still Apply
The free withdrawal cancels the insurance company’s charge. It does nothing to the IRS.
For a non-qualified annuity (one bought with after-tax dollars outside a retirement account), IRC Section 72(e) treats early withdrawals on an earnings-first basis. Every dollar you pull out is taxable as ordinary income until all the accumulated gain is exhausted; only after that do withdrawals come from your tax-free principal.4Office of the Law Revision Counsel. 26 U.S. Code 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts For a qualified annuity held inside an IRA or employer plan funded with pre-tax money, the entire withdrawal is generally taxable because there’s no after-tax basis to protect.5Internal Revenue Service. Publication 575 – Pension and Annuity Income Whatever portion is taxable gets added to your other income and taxed at your ordinary federal rate.
If you’re under 59½, the IRS adds a 10 percent additional tax on the taxable portion, on top of the regular income tax. Several exceptions eliminate that penalty:4Office of the Law Revision Counsel. 26 U.S. Code 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts
- Distributions to a beneficiary after the owner’s death.
- Total disability as defined by the tax code.
- Substantially equal periodic payments calculated over your life expectancy (or the joint life expectancy with a beneficiary), continued for at least five years or until you reach 59½, whichever is later. Modifying the schedule early triggers retroactive penalties plus interest.
- Payments from an immediate annuity, where income begins within one year of purchase.
The substantially equal payment route is the most common workaround for owners who need income before 59½, but it locks you into a rigid schedule. Breaking the pattern once can unwind years of penalty-free treatment.
Effect on Death Benefits and Living Benefit Riders
A free withdrawal reduces your account value. It can also reduce a guaranteed death benefit or a living benefit rider, sometimes by more than the dollars you actually took out.
Many contracts reduce the death benefit dollar-for-dollar for withdrawals up to a specified limit, such as the free withdrawal amount, and proportionally beyond it. A proportional reduction cuts the benefit by the same percentage as the withdrawal represents of the account. Withdraw $30,000 from a $200,000 account (15 percent) and a proportional reduction shaves 15 percent off the death benefit, which can be considerably more than $30,000 if the guaranteed amount exceeds the account value.6SEC. Form of Combination Roll-Up Value and Periodic Value Death Benefit Rider
Guaranteed lifetime withdrawal benefits generally protect the benefit base as long as withdrawals stay within the rider’s specified annual limit. Withdrawals above that limit reduce the benefit base proportionally, permanently lowering your future guaranteed income.7Society of Actuaries. Variable Annuity Guaranteed Living Benefits Utilization – 2015 Experience Staying within the free withdrawal amount protects both the account and the rider guarantees.
Other Ways to Avoid the Surrender Charge
Some contracts include waivers that go beyond the standard free withdrawal in specific hardship situations, giving you access to more than the annual percentage without a surrender charge.
- Nursing home or long-term care confinement. Many contracts waive surrender charges if the annuitant is confined to a hospital or nursing facility for a minimum number of consecutive days, typically 30 to 90 depending on the contract. Proof of confinement is required, and the qualifying stay generally can’t have started before the contract was issued.8SEC. Nursing Home Waiver Rider
- Terminal illness. A terminal illness waiver typically requires a physician’s certification of a life expectancy of 12 months or less; some contracts set the threshold at 6 or 24 months.
- Death of the owner. Most contracts waive surrender charges entirely when a beneficiary claims the death benefit.
These waivers aren’t universal. They may be built into the base contract, sold as optional riders for an added cost, or unavailable altogether. Confirm what your contract includes before you need it, because adding a waiver after issue is rarely an option.
How to Request a Free Withdrawal
The process is straightforward, but small errors delay payment. You’ll need your contract number, a government-issued ID, and your bank’s routing and account numbers for an electronic transfer. Most carriers provide a withdrawal request form through their online portal or by phone.
On the form, you specify the dollar amount and choose a federal tax withholding preference. If you elect no withholding, set money aside for the tax bill when you file your return. The insurer reports the distribution to the IRS on Form 1099-R, and the distribution code on that form tells the IRS whether the withdrawal was taken before or after age 59½.9Internal Revenue Service. Instructions for Forms 1099-R and 5498 Processing typically takes five to ten business days after the carrier receives complete paperwork. Electronic transfers usually arrive within two business days after approval; paper checks take longer.