What does it mean to surrender a 403b?
Early withdrawals from a tax-sheltered 403(b) plan may be subject to surrender charges. Find out what it means to surrender a 403(b).
If you work for a public school, hospital, or other non-profit organization, you may have a 403(b) with your employer. A 403(b) plan, also referred to as a tax-sheltered annuity, allows workers to make pre-tax contributions to the plan. Although a 403(b) is designed to supplement your income in retirement, it is possible to access these funds at any time.
Surrendering a 403(b) plan means that you are withdrawing money from your annuity before the end of the surrender period. Typically, the surrender period is the period when an investor cannot cash out an annuity without paying a surrender fee. However, if you wait until the surrender period expires, you can cash out, cancel, or sell your annuity without incurring a surrender fee.
How to Surrender a 403(b) Plan
If you want to close out your tax-sheltered annuity, you will receive the cash value of your annuity minus any fees and taxes. Here is how to surrender an annuity:
Review the annuity contract
The first step is to review the annuity contract to check if you are eligible for any waivers on early close out. Allowed exclusions may include death, terminal illness, or disability.
Find out the surrender period
Check the annuity contract to know the surrender period, and the number of years left for the surrender period to lapse. The surrender period ranges from 6 to 8 years or more, and the surrender fee declines each year until the period lapses.
Fill out the surrender form
Obtain a surrender form from the plan administrator and fill out your information. Make sure to provide the correct name, address, and social security number. If you want to close out the entire annuity value, write 100% liquidation on the “distribution amount” section. Also, fill out the tax withholding section to determine how much taxes will be withheld.
Once you fill the required sections, submit the form alongside the annuity contract, and wait for your check to arrive. It can take 7 to 10 days for the surrender value check to arrive.
What is a Surrender Period?
The surrender period is the duration that 403(b) participants must wait before they can make an early withdrawal without paying a penalty. For example, if a 403(b) plan has an 8-year surrender period, you must wait until the period lapses to make a withdrawal. However, if the invested funds are withdrawn before the surrender period expires, you will incur a penalty.
Annuities use surrender periods to discourage investors from canceling or cashing in on long-term contracts. Typically, an investor may want to cancel the contract in a cynical market or when the invested assets are not performing well. However, if you do not need the money quickly or the assets generated above-market returns, you won't need to pull the funds during the surrender period.
A typical annuity may have a surrender period of 6 to 8 years, and a surrender fee starting from 6%. In many cases, the surrender fee decreases over time, mostly by 1% each year till the final year. This fee is charged as a percentage of the total amount withdrawn, and it could be a significant portion of your money if you withdraw too soon. If you wait until the surrender period has expired, you won’t pay surrender charges on the withdrawals you make.
What is a surrender fee?
A surrender fee is the charge incurred when you cancel, sell, or cash out your annuity before the surrender period has passed. If you cancel, sell or cash out your annuity early, the surrender fee will be assessed based on the withdrawal amount. You will receive the amount you cash out minus the assessed surrender fee.
The amount of surrender fee varies across products, issuing firms, and the holding period. Typically, the shorter the holding period, the higher the surrender fee will be. If you have a short time horizon and want to cash out soon, you may want to invest in annuities without a surrender charge.
However, if you prefer a long time horizon, and you are willing to wait until the surrender period lapses, you can invest in long-term annuities. Once the surrender period ends, the surrender fee will go away, and the issuing firm will no longer charge a fee if you decide to cash out or sell the annuity.
Practical Example of Surrender Fee
Assume that you have a 403(b) plan and you purchased a $10,000 annuity with a 7-year surrender period. The annuity has a 7% surrender fee in the first year and a 1% surrender fee in the final year. The surrender schedule is as follows:
Year 1: 7%
Year 2: 6%
Year 3: 5%
Year 4: 4%
Year 5: 3%
Year 6: 2%
Year 7: 1%
Year 8: 0%
If you cash out the full annuity in the fifth year, you will pay a surrender fee of 3% of the $10,000 annuity, which is equivalent to $300. If you cash out in the seventh year, you will pay a surrender fee of 1%, which is equivalent to $100. If you cash out in the eighth year, you could withdraw the full $10,000 without paying a surrender fee.
Why does a 403(b) plan charge for early surrender?
403(b) plans may impose surrender charges for early annuity withdrawals for the following reasons:
Once you buy an annuity, the 403(b) plan invests the money in long-term investments with a potential to earn higher returns. Cashing out too early means that the retirement plan will have to pull out the funds before the maturity period. The surrender charge aims to discourage early withdrawals so that the funds grow to maturity.
Offset operating cost
Firms charge a standard fee to offset their administrative and operational costs. They also pay an upfront commission to the sales personnel that sell their investments. If an investor pulls out too soon, the issuing firm will not be able to afford these costs, and they charge a surrender fee to protect themselves against such losses.
How to avoid the surrender charge
No load annuities
Some annuities do not charge surrender fees, and they may be available through fee-only financial advisors who earn revenue from other sources other than commission. Although no-load annuities may have fees, you will typically pay lower fees than annuities with surrender fees.
Hold past the surrender period
You will only pay a surrender charge if you cash out the annuity before the surrender period expires. Therefore, you can avoid this fee by finding out the expiry date of the surrender period on your annuity contract, and holding the investment past this period.
Withdraw smaller amounts
Some annuity contracts have a withdrawal provision that lets investors withdraw a portion of their annuity value without triggering a surrender charge. Most annuities allow investors to cashout up to 10% of the annuity value each year without owing a surrender charge.
Take advantage of fee waivers
In some instances, the annuity may offer surrender charge waivers, which may be provided in the contract. Check your contract for “crisis waivers” and the steps required to get the surrender fee waived. For example, if the annuitant dies, is diagnosed with a terminal illness, or goes to a nursing home, the surrender fees may be waived to allow early withdrawals.