What Is a Surrender Fee?
A surrender fee is a penalty charged to an investor for withdrawing funds from an insurance or annuity contract early or canceling the contract. Surrender fees act as an incentive for investors to maintain their contracts and reduce the frequency of early withdrawals. Investors may run into surrender fees for other products, such as mutual funds.
Key Takeaways
- A surrender fee is a penalty for taking an early withdrawal from an annuity or canceling it altogether.
- A surrender fee might apply to a mutual fund, too, but it will usually be short term.
- The fee can be steep, so avoid such products if you foresee the need for liquidity in your investments.
- A surrender fee is alsoreferred to as a surrender charge. If you cancel your life insurance policy, for example, you will be hit with a surrender charge.
How a Surrender Fee Works
Surrender fees vary among insurance companies that offer annuity and insurance contracts. A typical annuity surrender fee could be 10%of the funds contributed to the contract within the first year it is effective. For each successive year of the contract, the surrender fee might drop by 1%. Thus, the annuitant, in this case, would effectively have the option of no-penalty withdrawals 10 years after the contract was signed.
Surrender feescan apply forperiods as short as 30 days or as long as15yearson some annuity and insurance products.In the case of mutual funds, a short-term surrender feemay apply. This usually penalizes the investor for selling shares within 30 and 90 days of its purchase. The charges are designed todiscourage people from using investment shares asshort-term trades.This arrangement is also commonwithvariable annuities.If you have to cash in an annuity or insurance policy, make sure to check how much of the balance you'll be losing.
Some mutual funds impose a surrender fee to discourage short-term trading.
Reasons for Surrender Fees
Most investments that carry a surrender feepay an upfront commission to the salespeople who sell them. Theissuing company recoups the commissionthrough the fees it charges for the investment. If the investment is sold soon after it's purchased, the fees collected willnot cover the commission costs. Surrender feesprotect the issuer against these types of losses.
Should You Avoid Surrender Fees?
In general, it's smart toavoid investments with surrender charges, but life circ*mstances change and emergencies happen. If you crave flexibility, look for investments that don't lock up your money for long periods of time. If you're buying a life insurance policy,understand that itis along-term investment and thatyou will need topay premiumsfor a long time, even in the event of a job loss.In the case of an annuity product, make sure the benefits outweigh the lack of liquidity and flexibility.
