Many people use annuities to help them with their investing goals, but the terms of annuity contracts can be extremely complicated and tough to understand. Knowing the current cash value of an annuity is important in assessing your options, but among the traps for the unwary within annuities are surrender charges that can hit you if you try to close out your annuity within a certain initial time period. Below, we'll go through some of the aspects of how annuities work and how you can avoid surrender charges that affect the value of your annuity.
Annuity cash value
How an annuity works is pretty simple. To open an annuity, you'll need to make an initial premium payment, and some annuities provide for regular additional premium contributions on top of the lump sum deposit at the beginning. The premiums that you put into the annuity represent its initial cash value.
Over time, depending on the terms of the annuity, the cash value will vary based on the performance of the annuity's investments. Variable annuities can see substantial fluctuations in value, especially if you choose not to take advantage of certain protective guarantees that ensure that the cash value never falls below a particular amount. Fixed annuities typically see less volatility in their cash value.
Annuities provide for different ways to access your cash value, but fees known as surrender charges can apply if you try to access your annuity cash value too soon after buying the annuity. Some annuity companies make you pay surrender charges if you withdraw money for as long as the first 10 years you own the policy, and charges for withdrawals during the early years of the policy can be as much as 10%. Over time, surrender charges under the annuity tend to get smaller, and so the surrender value approaches the cash value of the annuity.
Further complicating the annuity process is that many policies refer to surrender value as the cash surrender value, while referring to cash value as described above as accumulated value. The lack of standardization of terms is another obstacle you have to overcome to make sure that you fully understand your annuity's terms.
When buying an annuity, it's important to know when you can get access to your money without surrender fees and whether you're willing to take on the risk of having to pay a substantial surrender fee if you need your money back unexpectedly. For the most part, investing in an annuity is designed to be a long-term commitment, and the differences between cash value and surrender value show just how costly a mistake it can be if you end up having to change your mind about an annuity.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at firstname.lastname@example.org. Thanks -- and Fool on!