Everyone has a place they go to gather their thoughts or find motivation. I went to my usual spot last week to think about blog topics, but the inspiration for this blog came from an unlikely source, as if it was sent down from the Gods.
A man and a young woman sat at the table in front of me. Within five minutes of their conversation, I realized he was a financial advisor.
I won’t bore you with all the details. Yes, we collectively known as financial advisors can be a boring bunch of people, but one thing he said specifically caught my ear. It was almost surreal, as the room quieted in anticipation of what he would say next.
He was explaining the surrender charge on her 403(b). He told her “it was a charge you shouldn’t worry about because you probably won’t be making any withdrawals, besides it’s an incentive to avoid withdrawals.”
I thought about this for a moment- considering the different angles. I don’t know if I’ve ever heard it explained in that manner. Next, amazement set in, followed by me squinting and starring into space to further contemplate this explanation. Then the fire alarm went off (just kidding). I almost wanted to thank this guy, and sweep in and tell this woman what a surrender charge is, how it works and what it’s not.
What is a Surrender Charge?
Quite simply, it is a fee paid by the annuity investor to take out some of their money. This fee applies if the withdrawal is during the surrender period.
How does it Work?
Surrender charges usually come in two flavors:
Fixed Period: Where the surrender charge is based on when you start the annuity. For example, if you started the annuity in 2017, the annuity could be free of surrender charges by 2024. In this example, the annuity has a seven-year surrender schedule. The number of years will vary depending on the insurance company.
Another variable is the percentage, which represents the actual fee on the withdrawal. If you dig in the prospectus of an annuity, you will probably see something that looks like this- 8%, 7%, 6%, 5%, 4%, 3%, 2%. This indicates the annuity has a seven-year surrender period with an 7% surrender charge in the second year, 6% charge in the third year, and so on until the eighth year.
Rolling Basis: This surrender charge setup is based on when you make each contribution to the annuity. So, each independent contribution is subject to the surrender schedule.
Using the surrender schedule above, a contribution made in 2017 will be free of surrender in 2024, while a contribution in 2018 will be free in 2025. The pattern will continue until 7 years after the last contribution.
Why is this Important to Know?
Not all 403b options have surrender charges. Ideally, you would want to know the details before making a choice. There are also ways to mitigate the surrender charge or avoid it all together. These strategies should be discussed with a qualified professional as there are many factors to consider.
What It’s Not
Let me be crystal clear, a surrender charge is NOT an act of benevolence by the insurance company. Therefore, it being an “incentive to avoid withdrawals” is bit of a farce.
There are additional layers to the fee structure of an insurance based 403b. Having a basic understanding of the fees will provide tremendous help in achieving your ultimate goals. I strongly encourage every teacher with a 403b to seek an objective second opinion about the current plan they are using.