Surrender Charges: Definition, How They Work, and Examples

What Is a Surrender Charge?

A surrender charge, also known as a "surrender fee," is a fee levied on a life insurance policyholder upon cancellation of their policy. It covers the costs of keeping the policy on the insurance provider’s books.

Key Takeaways

• A surrender charge is levied on a life insurance policyholder upon cancellation.
• It covers the costs of keeping the policy on the insurance provider’s books.
• The charge is usually waived if the insured party informs the insurer in advance of the cancellation.

Surrender Charge Explained

The surrender charge is usually waived if the insured party informs the insurer in advance of cancelling their life insurance policy and continues to pay for a period of time. This applies to investments such as B-share mutual funds, annuities, and whole life insurance. These investments pay upfront commissions to salespeople. Internal fees charged by the issuing company recoup the commission costs. However, if an investment is sold too early, the internal fees may not be enough to cover the commission costs, resulting in losses for the company. Surrender charges protect against such losses.

Surrender charges can be as short as 30 days or as long as 15 years for annuity and insurance products. For annuities and life insurance, the surrender fee typically starts at 10% if the investment is cashed in during the first year. The fee gradually decreases to 1% in the ninth year, with no surrender fees applicable in the tenth year or thereafter.

Mutual funds may have short-term surrender charges if the investment is sold within 30, 60, or 90 days. These charges discourage using investments for short-term trading. Variable annuities commonly have such arrangements. It is advisable to avoid cashing in annuities or insurance policies close to their anniversary dates.

Surrender Charges and the SECURE Act

Under the SECURE Act of 2019, annuities held in employer-sponsored 401(k) plans are now portable. This means that when leaving a job or retiring, individuals can transfer their 401(k) annuities to another employer-sponsored plan or an IRA, avoiding the need to liquidate the annuity and pay surrender charges or fees.

Should Surrender Charges Be Avoided?

Generally, it is recommended to avoid investments with surrender charges. Life circumstances can change, so it is wise to seek opportunities that offer flexibility rather than locking up funds for extended periods. However, exceptions exist for good annuities and life insurance policies based on individual circumstances. With life insurance, it is crucial to understand that it is a long-term investment requiring long-term premium payments, even in the event of a job loss. Regarding annuities, make sure the benefits outweigh the lack of liquidity and flexibility.

What Is a Surrender Charge or Fee?

A surrender charge is a fee imposed on a life insurance policyholder upon cancellation of their policy.

What are some Typical Examples of a Surrender Charge?

For annuities and life insurance, the surrender fee usually begins at 10% if the investment is cashed in within the first year. It diminishes to 1% if cashed in during the ninth year, and there are no surrender fees after the tenth year or longer. Surrender charges can apply for as little as 30 days or as much as 15 years for certain annuity and insurance products.

How Do You Avoid Surrender Charges?

Prior to purchasing life insurance, understand that it is a long-term investment requiring premium payments over many years. Be aware that premiums must still be paid, even in the event of a job loss, to avoid surrender charges.