How to get out of an annuity: the five exit routes and what each costs

There are five ways out of an annuity: cancel inside the free look window, take penalty-free withdrawals, surrender the contract in full, exchange it for a different contract under IRC §1035, or convert it to income instead of exiting. Which of those are actually open to you depends almost entirely on two facts — how long ago you bought the contract, and whether it has already been annuitized. Once income payments have begun under a life or fixed-term payout, most of the exits close permanently.

The costly mistake people make is treating "getting out" as one decision. It is really two: what the insurer charges you to leave, and what the IRS charges you on the money you take. Those are separate bills, calculated separately, and a route that minimises one can maximise the other.

Step one: work out which stage your contract is in

Every annuity sits in one of two phases, and the phase determines your options.

An annuity in the accumulation phase still has an account value. You can see a balance, the insurer credits interest or investment returns to it, and you have not yet converted it into a payment stream. Deferred fixed annuities, MYGAs, fixed-index annuities, variable annuities and RILAs all live here until you tell the insurer otherwise. Every exit route below is available in some form.

An annuity in the payout phase has been annuitized. You exchanged the account value for a schedule of payments, and in most contracts that exchange is irrevocable. A single premium immediate annuity is in the payout phase from day one. Here your options narrow to two, and neither is guaranteed to exist.

Check your last statement. If it shows an account value and a surrender charge schedule, you are in accumulation. If it shows only a payment amount and a payment date, you are annuitized.

Route 1: the free look period, if you are still inside it

Every state requires a free look period on newly issued annuity contracts — a window after delivery during which you can cancel and get your money back. In most states the minimum is around ten days, with longer windows common for replacement contracts and for older buyers, and some states mandating considerably more. The exact length is set by your state insurance department and stated in the contract itself, usually on the first page or the delivery receipt.

Inside the free look window there is normally no surrender charge and no market value adjustment. What you get back depends on the product: fixed contracts typically return the full premium, while variable contracts in some states return the account value, which may be more or less than you paid if markets moved.

Two practical points. The clock usually starts on delivery rather than on the application date, so the delivery receipt matters. And cancelling means writing to the insurer within the window — a phone call to the agent who sold it is not a cancellation.

Route 2: penalty-free withdrawals, if you only need some of it

Most deferred annuities allow a percentage of the account value to be withdrawn each contract year without a surrender charge, commonly around ten percent, sometimes only after the first year. Some contracts allow withdrawal of credited interest only. Some waive charges entirely on confinement to a nursing home or on a terminal illness diagnosis.

This is the cheapest way to get cash out of a contract you otherwise want to keep. Read the exact wording before relying on it: whether the free amount is calculated on the original premium or the current account value varies, and an unused allowance usually does not carry forward.

If your contract has a guaranteed lifetime withdrawal benefit, a withdrawal above the rider's permitted amount can permanently reduce the benefit base — often by more than the dollar you took out. That mechanic is covered in our piece on the annuity income rider.

Route 3: full surrender, and what it actually costs

Surrendering means handing the contract back for its cash surrender value. Two deductions stand between the account value and the cheque.

The surrender charge is a declining percentage applied during the surrender period, which commonly runs somewhere between three and ten years depending on the product. Illustratively, a contract with a seven-year schedule might charge 7% in year one, 6% in year two and so on to nothing in year eight. Your contract's own schedule is the only one that matters — these are examples, not standard figures.

The market value adjustment applies on many fixed and multi-year guaranteed contracts. It adjusts the payout up or down based on how interest rates have moved since issue: if rates have risen, the adjustment usually goes against you. It is applied in addition to the surrender charge, not instead of it. Our article on annuity fees and surrender charges walks through how the two stack.

One thing worth checking before you surrender: on many contracts the surrender charge falls to zero on a fixed date. Waiting three months to cross that date can be worth more than anything else on this list.

Route 4: a §1035 exchange into a different contract

If the problem is the contract rather than owning an annuity at all, IRC §1035 lets you move the value from one annuity to another without triggering income tax on the gain. The cost basis carries over, the deferral continues, and the transfer must go company to company — take the money into your own hands first and it becomes a taxable distribution.

What §1035 does not do is waive the surrender charge or the market value adjustment. Those belong to the contract you are leaving and apply wherever the money goes. Nor does it avoid a fresh surrender schedule on the new contract, which is the most common reason an exchange that looked sensible turns out not to be.

Partial exchanges are permitted. Under Rev. Proc. 2011-38, a direct transfer of part of an existing annuity's cash surrender value into a second annuity is treated as a tax-free exchange provided no amount — other than payments received as an annuity for ten years or more, or over one or more lives — is taken from either contract during the 180 days beginning on the transfer date. Take a withdrawal inside that window and the IRS applies general tax principles to work out what really happened. The mechanics are covered further in annuity 1035 exchange.

Route 5: converting it to income rather than leaving

If what you actually want is access to the money rather than escape from the insurer, annuitization turns the account value into a payment stream with no surrender charge. Nothing is deducted for leaving, because you are not leaving.

The trade is that this is generally the most irreversible option on the list: you give up the account balance and its liquidity in exchange for a schedule. It is the right answer when the payout terms are genuinely competitive, and the wrong one when you are annuitizing simply to dodge a surrender charge that expires in eighteen months anyway. Compare the shape of a payout with our annuity payout calculator.

If the contract is already annuitized

Once payments have begun, the account value no longer exists, so there is nothing to surrender. Two possibilities remain.

Some contracts include a commutation provision on the guaranteed or period-certain portion, letting the remaining certain payments be exchanged for a discounted lump sum. Many contracts do not offer it, and where it exists the discount rate is set by the insurer.

Otherwise, guaranteed payments can sometimes be sold on the secondary market, in the same way structured settlement payments are. This is a sale at a discount, not a refund, and the arithmetic is unforgiving on payments far in the future — see selling annuity payments. Life-contingent payments, which continue only while the annuitant is alive, are generally neither commutable nor saleable.

The tax bill is a separate calculation

None of the routes above tell you what you owe. That depends on how the annuity was funded.

For a non-qualified annuity bought with after-tax money, withdrawals from a deferred contract come out earnings first under IRC §72(e). The earnings portion is ordinary income; your original after-tax premium comes back untaxed once the earnings are exhausted. For a qualified annuity funded with pre-tax retirement money, the whole distribution is generally taxable. The split is explained in qualified vs non-qualified annuity.

On top of income tax, an additional 10% applies to the taxable portion of distributions taken before age 59½ — under IRC §72(q) for non-qualified annuities and IRC §72(t) for qualified money. Both provisions carry exception lists covering circumstances such as death, disability and substantially equal periodic payments.

The point that surprises people is that the two bills arrive together and pull in different directions. A route that avoids the insurer's charge entirely, such as annuitizing, can still produce a large tax bill; a §1035 exchange defers the tax completely but does nothing about the charge. Read how annuities are taxed before choosing.

Comparing the routes

The table below is an illustrative summary of how the routes differ in structure. It is not a recommendation, and the figures in your own contract govern.

Route	Insurer's charge	Tax triggered	Available when
Free look cancellation	None	None	Only within the state-set window after delivery
Penalty-free withdrawal	None up to the contract limit	Yes, on the taxable portion	Accumulation phase
Full surrender	Surrender charge plus any MVA	Yes, on the full taxable gain	Accumulation phase
§1035 exchange	Surrender charge plus any MVA	Deferred	Accumulation phase
Annuitization	None	Taxed as income is received	Accumulation phase
Commutation or sale	Discount set by insurer or buyer	Yes	Payout phase, if permitted

If you believe the contract was misrepresented

That is a different problem from wanting out, and it has its own route. Fixed and indexed annuities are regulated by state insurance departments, which handle complaints and enforce suitability and best-interest standards based on the NAIC model regulations. Replacement transactions carry their own disclosure requirements under the NAIC replacement model regulation, designed precisely so a buyer can see what they are giving up. Variable annuities and registered index-linked annuities are securities sold with a prospectus, so complaints run through the SEC and FINRA as well. Whichever applies, the paperwork signed at purchase — the suitability form, the replacement disclosure, the illustration — is where a complaint starts.

Rates, charges and state rules change, and every contract differs. Treat every figure above as an example of how the mechanics work, and verify your own numbers against your contract and a current quote before acting.

Frequently asked questions

Can I cancel an annuity at any time and get my money back?

Only inside the free look window. After that you can surrender, but "getting your money back" is not the right description — you receive the cash surrender value, which is the account value less any surrender charge and market value adjustment, and you may owe income tax and a 10% additional tax on the gain.

Is there a way to leave an annuity without paying a surrender charge?

Yes, in three situations: inside the free look period, within the contract's annual penalty-free withdrawal allowance, and after the surrender schedule has run to zero. Some contracts also waive charges on nursing home confinement or terminal illness. Annuitizing avoids the charge as well, but replaces the balance with a payment schedule.

Does a 1035 exchange avoid the surrender charge?

No. A §1035 exchange defers the income tax on the gain; the surrender charge and market value adjustment belong to the contract you are leaving and still apply. The new contract will usually start its own surrender schedule.

What if the annuity is inside my IRA?

The insurer's surrender charge still applies, but the tax treatment follows the IRA rather than the annuity — a direct transfer between IRA custodians is not a taxable event. Moving from an annuity into another investment inside the same IRA does not itself create a tax bill.

This article explains how the exits work; it is education, not personal financial advice. Your contract terms, your state's rules and your own tax position determine the answer in your case.