Annuities are designed to be long-term commitments, and the contracts are written to reflect that. But circumstances change. People find themselves in annuities that no longer fit their needs, that were sold to them without adequate explanation, or that carry terms they now understand to be unfavorable. If you are in that position, you have options, though none of them are without cost or consequence.
This article walks through the four main ways to exit an annuity, what each one costs, and how to think through the decision.
Option 1: Use the Free Look Period (If You Just Purchased)
Every annuity sold in the United States comes with a free look period, a window of time after you receive the policy during which you can cancel the contract and receive a full refund of your premium, with no surrender charge and no questions asked.1
Free look periods vary by state, but most range from 10 to 30 days. Some states require longer periods for buyers over age 65. The clock typically starts when you physically receive the policy documents, not when the contract is issued.
If you are within the free look window and have any doubts about the product, this is by far the cleanest and least expensive way to exit. Contact the insurance company directly, request a cancellation, and follow their instructions for returning the policy.
Once the free look period expires, you move into the surrender period, and the costs of exiting increase substantially.
Option 2: Surrender the Annuity (Full or Partial)
If the free look period has passed, the most direct way to exit is to surrender the annuity. A full surrender means canceling the contract entirely and receiving the current account value, minus any applicable surrender charge.
A partial surrender allows you to withdraw a specific amount while keeping the rest of the contract in force. Most contracts allow you to withdraw up to 10% of the account value per year without a surrender charge (the free withdrawal provision). Amounts above that threshold trigger the surrender charge on the excess.2
The cost of a full surrender depends on where you are in the surrender schedule. A typical seven-year schedule might look like this:
| Contract Year | Surrender Charge |
|---|---|
| 1 | 7% |
| 2 | 6% |
| 3 | 5% |
| 4 | 4% |
| 5 | 3% |
| 6 | 2% |
| 7 | 1% |
| 8+ | 0% |
Beyond the surrender charge, you will also owe ordinary income tax on any earnings in the contract (the amount above your original premium). If you are under age 59½, the IRS also assesses a 10% early withdrawal penalty on the taxable portion.3
Before surrendering, calculate the total cost: surrender charge plus income tax plus any IRS penalty. In some cases, the combined cost can exceed 30% to 40% of the taxable gain, which is a significant reason to explore alternatives.
Option 3: Execute a 1035 Exchange
If your goal is not to get cash out but to move into a better product, a 1035 exchange allows you to transfer the value of your annuity directly to a new annuity contract without triggering income taxes on the accumulated gain.4
Named for Section 1035 of the Internal Revenue Code, this provision allows a tax-free transfer between qualifying insurance and annuity contracts. The transfer must be made directly between insurance companies; if you receive the funds yourself first, the exchange loses its tax-free status.
A 1035 exchange does not eliminate the original contract's surrender charge. You will still owe the surrender charge on the amount transferred, deducted from the value before it moves to the new carrier. The new contract will also have its own surrender period, so you are effectively restarting the clock.
A 1035 exchange makes sense when the new product offers meaningfully better terms (lower fees, better income guarantees, or a more suitable structure) and when the remaining surrender charge on the old contract is modest enough that the improvement justifies the cost. It does not make sense if you are being pressured into a new product primarily to generate a new commission.
The Financial Industry Regulatory Authority (FINRA) has specifically flagged unsuitable 1035 exchanges as a compliance concern, noting that the exchange of one annuity for another should be in the client's best interest, not the agent's.5
Option 4: Sell Your Annuity Payments on the Secondary Market
If you own a structured settlement annuity or an immediate annuity that is already paying out, you may have the option to sell some or all of your future payments to a factoring company in exchange for a lump sum today. This is known as a secondary market annuity transaction.6
The factoring company purchases your right to receive future payments and pays you a discounted lump sum. The discount reflects the time value of money and the factoring company's profit margin. Discount rates typically range from 9% to 18% of the present value of the payments, meaning you will receive substantially less than the total of all future payments you are selling.
Most secondary market transactions involving structured settlements require court approval to protect the seller from making a decision that is not in their best interest. The process can take 45 to 90 days.
This option is not available for all annuity types. Deferred annuities that have not yet begun paying out generally cannot be sold on the secondary market in the same way.
What to Consider Before You Exit
Before taking any action, it is worth stepping back and asking why you want to exit. The answer shapes which option makes the most sense.
If you need cash urgently, a partial surrender using the free withdrawal provision may be the least costly path, provided the amount you need falls within the allowable threshold.
If you believe you were sold the wrong product, a 1035 exchange into a more suitable annuity may preserve your tax deferral while improving your terms, at the cost of the remaining surrender charge.
If you simply want out of the annuity category entirely, a full surrender is the most direct path, but you should calculate the total tax and penalty cost before proceeding. In some cases, waiting one or two more years until the surrender charge steps down significantly can save thousands of dollars.
If the annuity was sold to you in a way that you believe was unsuitable or deceptive, you may have recourse through your state's insurance department or through FINRA arbitration if the product was a variable annuity. A qualified financial professional or attorney can help you evaluate whether a complaint or claim is appropriate.
The Most Important Step: Get a Second Opinion
Annuity contracts are complex, and the cost of exiting is not always obvious from the contract summary. Before making any decision, it is worth having an independent professional review the full contract, calculate the total cost of each exit option, and help you weigh that cost against the alternatives.
A review does not commit you to any course of action. It simply ensures that you are making a fully informed decision rather than reacting to a situation without complete information.
The information in this article is for educational purposes only and does not constitute financial, tax, or legal advice. Annuity contracts vary significantly by carrier and product. Consult a qualified financial professional before making any decisions about your annuity.
Footnotes
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ImmediateAnnuities.com. "Can I Cancel My Annuity?" https://www.immediateannuities.com/annuity-shopper/can-i-cancel-my-annuity.html ↩
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Annuity.org. "Surrendering an Annuity: Examples and Tips for Avoiding Charges." https://www.annuity.org/selling-payments/surrendering/ ↩
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Internal Revenue Service. "Publication 575: Pension and Annuity Income." https://www.irs.gov/publications/p575 ↩
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Annuity.org. "1035 Exchange: Refinancing an Annuity." https://www.annuity.org/annuities/1035-exchange/ ↩
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Financial Industry Regulatory Authority (FINRA). "Exchange Variable Annuity." https://www.finra.org/investors/insights/exchange-variable-annuity ↩
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Annuity.org. "Secondary Market Annuity Buyers." https://www.annuity.org/selling-payments/buyers/ ↩