When you need money from an annuity, most insurance companies allow you to withdraw a portion of the annuity's account value. However, this might also incur penalties and fees from the insurance company. On top of that, you'll have to pay the IRS a penalty of 10 percent for early withdrawals from the annuity prior to age 59 1/2 plus income taxes. There is one option that allows you access to your annuity's policy values without taxes and penalties: the annuity policy loan.
An annuity policy loan, when available, allows you to make tax-free loans against the value of your policy. You must contact the insurance company and request a policy loan. The insurer will process your request as long as there is cash value available in the annuity. The insurance company does not require a policy loan application. The loan is secured by the funds in the policy.
The benefit of an annuity policy loan is that you gain access to the cash in your annuity without having to pay taxes, penalties or fees to either the insurer or the IRS. This money may be used for any reason. When compared to withdrawals, an annuity policy loan is an inexpensive option to access your annuity if you need money in an emergency.
The disadvantage to annuity policy loans is that insurance companies normally limit the loan amount. The loan may be restricted, for example, to $50,000. In addition to this, the IRS requires that annuity policy loans be repaid on a schedule. If the annuity loan is not repaid, the loan is considered a taxable distribution of annuity proceeds.
Annuity loans are best used for emergency purposes. When you don't have any other source of funds, you may use the annuity policy to provide money that you otherwise would not have. If you need more money than the annuity allows for in terms of a policy loan, you will need to make a withdrawal from the annuity. In lieu of using an annuity, you might also want to consider using a high cash value life insurance policy. High cash value life insurance policies are life insurance policies that allow access to anywhere between 30 percent and 90 percent of the premiums you pay in the first year, with the amount of available premium increasing every year in addition to interest that is credited to the policy. A life insurance policy generally allows you to borrow up to all of the available cash value with no restrictions on a tax-free basis. Policy loans do not need to be repaid to the policy until your death, in which case they will be deducted from the death benefit.