What is Surrender Fee
A surrender fee is a charge levied against an investor for the early withdrawal of funds from an insurance or annuity contract, or for the cancellation of the agreement. Surrender fees act as an economic incentive for investors to maintain their contract, and they allow the insurance company to have reasonable expectations for the frequency of early withdrawals. A surrender fee is also referred to as a "surrender charge."
BREAKING DOWN Surrender Fee
Surrender fees can apply for time periods as little as 30 days or as much as 15 years on some annuity and insurance products. Surrender fees vary among insurance companies and among annuity and insurance contracts, but a typical annuity surrender fee could be set as a 10 percent (of the funds contributed to the contract) charge levied for withdrawal in the first year. For each successive year of the contract, the surrender fee could drop by 1 percent, for example, effectively giving the annuitant the option of no-penalty withdrawal after 10 years in the contract.
In the case of mutual funds, short-term surrender fees can apply if a buyer sells the investment within 30, 60 or 90 days. These surrender charges are designed to discourage people from using an investment as a short-term trade. This arrangement is also common with variable annuities. If you have to cash in your annuity or insurance policy, it's smart to make sure you're not close to an anniversary date.
Reasons for Surrender Fees
Most investments that carry a surrender fee pay upfront commissions to the salespeople who sell them. The issuing company then recoups the commission through internal fees it charges in the investment. However, if an investment is sold before enough years pass, those internal fees will not be enough to cover the commission costs, which results in the issuing company losing money. Surrender fees protect against these types of losses.
Should Surrender Fees Be Avoided?
In general, it's smart to avoid investments with surrender charges. Life circumstances change. Look for opportunities that offer flexibility, rather than investments that lock up your money up for long periods. Of course, there are exceptions for good annuities and life insurance policies, depending on an individual's life circumstances. With a life insurance policy, before you buy it, understand it is a long-term investment and that you will need to pay premiums for a long time. It'll be important to continue paying premiums 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.