There are two types of annuities: immediate and deferred annuities. Generally, you cannot get your principal back from an immediate annuity as a lump sum because the annuity company annuitizes the premium and turns it into an income stream that lasts for life.
Fixed, variable and indexed annuities are types of deferred annuities. Typically, people can get their full principal back from a fixed annuity at any time. Variable annuities and indexed annuities assess penalty fees of between 6 and 20 percent for principal withdrawals during the accumulation phase.
Fixed annuities are intended to grow during the accumulation phase, which normally lasts between four and 10 years. After the accumulation phase, people can take the lump sum or annuitize it into an income stream. Variable annuities also have accumulation phases that last for between four and 10 years, but with indexed annuities the phase often lasts for 15 or 20 years. Immediate annuities normally begin making monthly payments to the annuitant one month after the contract begins.
The IRS uses age 59 1/2 as retirement age for taxation purposes, and anyone who withdraws money from an annuity prior to that age must pay a 10 percent premature withdrawal tax penalty. Additionally, the contract owner must pay income tax on any earnings in the the account. Annuities follow the last-in-first-out rule, which means when partial withdrawals are made, interest gets paid out before principal. This forces people to receive the taxable part of the annuity before they can access the already taxed principal.
Some fixed annuity contracts include a clause that involves the contract holder waving the standard return of principal feature, known as the money back guarantee. In exchange for waiving the principal guarantee, annuitants receive a slightly higher rate of interest on their investment. Some contracts still allow annuitants to make annual principal withdrawals of up to 10 or 15 percent without charge, but larger withdrawals incur penalty fees of 6 or 7 percent.
Some U.S. states, including Texas and Florida, have laws that entitle annuity owners to a free-look before the annuity contract takes effect. Many states have similar provisions for other kinds of insurance contracts. The free-look window lasts for 10 days, and contract owners receive a full refund of principal if they cancel the contract before the end of the 10-day window. Neither the IRS nor the insurer can assess a penalty in these situations because the cancellation means that the contract never actually took effect.