An annuity is typically used as a retirement income vehicle. You invest, either in a lump sum or cash deposits regularly and build up savings over a period of time. After the accumulation phase, you or your family members receive income for a pre-determined stretch of time. The return can be collected as monthly, quarterly or yearly payments. Typically, an annuity is the backbone of retirement income. This income might also be used to pay off your debts. However, it doesn’t make sense to cash out your annuity midway. It is better if you opt for consolidation of debt, and eliminate your debt gradually.
Cashing out an annuity should be your last remedy to do away with your debts. Usually annuities are kept as a security for uncertainties, since they provide a regular source of income in the future. It is obvious that, if you cash out your annuity early, you’ll end up getting less than the matured amount.
Let’s look at some of the consequences when you cash out early.
1. Taxes: Annuities tax-deferred- not tax free. But when the income comes out, it is taxable. So if you pull money out to pay off debts, be prepared for a tax hit. And if it’s in an IRA, and you’re under 59.5 yrs old, forget it. You’ll be slammed with a IRS penalty of 10 %.
2. Surrender Charge: If the annuity is surrendered before the date of maturity, you may be subject to a surrender charge which can eat into principal and deferred income. So, the amount you take out will be reduced further.
3. Limited to Present Value: If you cash out an annuity with a lifetime income rider, you’re forefitting the potential income from that rider, and will only get the account value less surrender charges. However, in the case of fixed annuity, if you wait till the maturity date, you’ll be able to obtain your full value.
4. Quality of your Current Annuity: Unfortunately, today’s marketplace has very low rates. So if you have a fixed annuity or other type of annuity with a higher guaranteed accumulation value, and your surrender it, you’ll be looking at taxes plus lower replacement rates.
Unless you are really in a jam, it really rarely makes sense to surrender an annuity to pay off debts. That’s why good financial professionals will counsel you to only invest in an annuity with truly long term money- if you need liquidity, stick to CD’s and more saleable investments.
An annuity is your safety net- tuck it away to know you have guaranteed future income or lump sums coming in, and deal with debt in other ways.