What Is a Surrender Charge?

A surrender charge is a fee levied on a life insurance policyholder upon cancellation of their life insurance policy. The fee is used to cover the costs of keeping the insurance policy on the insurance provider's books. A surrender charge is also known as a "surrender fee."

Surrender Charge Explained

The surrender charge is usually waived if the insured party informs the insurer in advance of the cancellation of their life insurance policy, and then continues to pay for a period of time before canceling the policy.

Also, most investments that carry a surrender charge, such as B-share mutual funds, annuities, and whole life insurance, 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 charges protect against these types of losses.

Surrender charges can apply for time periods as little as 30 days or as much as 15 years on some annuity and insurance products. For annuities and life insurance, the surrender fee often starts at 10% if you cash in your investment in year one. It goes down to 1% if you cash it in during year nine and no surrender fees in year 10 or longer.

In the case of mutual funds, short-term surrender charges 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.

Surrender Charges and the SECURE Act

Under the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, annuities held in employer-sponsored 401(k) plans are now portable. This means that if you leave your job or retire, you can transfer your 401(k) annuity to another employer-sponsored plan or an IRA without having to liquidate the annuity and pay surrender charges or fees.

Should Surrender Charges 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 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.