Understanding Annuities: Maturity Date and Surrender Charges

Maturity Date and Surrender Charges

The recent confusion surrounding the “maturity date” is exacerbated because the term is a misnomer originating from life insurance policy language. There it refers to the date at which the policy matures and an endowment or income is automatically paid. For an annuity, the maturity date or more appropriately, the “income date” is the date at which periodic income will be paid. For most annuities, the income date is flexible, meaning that it can be changed. Thus, an annuity owner can extend the maturity date allowing the owner to have a longer period for the cash value to accumulate tax-deferred. All annuities include a date at which deferral is no longer allowed and income must be taken from the annuity.
While some annuities may initially establish a maturity date that is at the end of the surrender charge period, there is no necessary relationship between the surrender charge period and the maturity date. To suggest that the surrender charge period lasts until the maturity date is incorrect. An egregious example of confusing income date with surrender charge period occurred at a hearing NAFA attended in California this past August. Someone incorrectly testified that annuities lock up your money for 40 or 50 years and used an example of a client who “couldn’t get at his money until he turned age 140.” While we corrected this misinformed testimony, unfortunately, this misinformation continues to occur as it is being repeated in various media.
So, fixed annuities have maturity or income dates that permit the consumer to defer an annuity until some later age typically in the range of 85 to 95. However, saying this is the first date you can get your money free of surrender charges is like saying if you can’t get off Interstate 80 from New York until you reach San Francisco. A fixed annuity is a financial highway with many exits before you MUST because the highway ends.
Simply, the maturity date is the date that annuity payments must begin, which date may in most contracts be changed, and it is not necessarily the first date on which they may do so without surrender penalties.

Surrender Charges

Surrender charges are a way for any financial company to be able to credit higher interest rates and to recoup expenses when the owner prematurely terminates the contract. The surrender charge reduces the likelihood the insurance carrier will have to liquidate its investments prematurely at a loss. It also assures that the company will recoup its expenses over the surrender charge period. With this assurance comes a decreased need to withhold funds to protect against asset loss on excessive withdrawals. That in turn increases the ability to credit a higher interest rate to the contracts. Moreover, reducing the likelihood and potential severity of early surrender is what allows the company to provide the guaranteed benefits under the contract, including a guaranteed interest rate.

The length of surrender charges varies from 3 years to 17 years and the average is 10 years. Policies with longer surrender charge periods often include up front premium bonuses. Longer surrender charge durations also afford the insurance carrier the ability to invest longer term which allows the carrier to offer higher interest credits to the client.

While annuities assess surrender charges, which results in surrender proceeds less than the full contract value, few non-insurance investments offer any kind guaranteed selling price,. Most annuity contracts also waive surrender charges in many circumstances: death, terminal illness, nursing home confinement, federal tax law required minimum distributions, conversion to a stream of income, and unemployment. Most annuities have a specified annual surrender charge free withdrawal amount such as 10% of the accumulated value. No other financial instrument offers the ability to receive all or a part of the value free of penalty and risk of decrease in value under so many circumstances.

As with any insurance product, an annuity should be selected to fit the particular needs of the purchaser. Also, like any financial product, they will be suitable for some, but not all people, and for some, but not all, of their financial assets. Like most insurance retirement products, annuities are designed to be held for a number of years. Accordingly, annuities—whether fixed or variable—may not be suitable for any person, regardless of age, who could not be expected to keep their product in force for the surrender period of the contract or who needs income before annuitization is allowed without penalty.