Is an IRA Surrender Charge a Miscellaneous Itemized Deduction?

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Generally, IRAs themselves do not charge a surrender charge. But annuities frequently do, in the early years of the annuity contract. When an annuity owner decides to cash out an annuity within the IRA, he may be subject to taxes, fees and penalties, depending on the situation. The surrender charge within the IRA, however, is not a deductible expense.

Annuities

An annuity is a contract whereby an individual gives money to an insurance company. The insurance company, in turn, promises the annuity owner a stream of income, starting either immediately or at some point in the future. Annuities are tax-deferred savings or investment vehicles. You don't pay capital gains or income taxes on anything within the annuity. Instead, you pay income taxes on any gains you have when you take money out of the annuity.

Surrender Charges

When you buy an annuity, you typically do not pay a commission to a salesman, as you do when you buy a stock or shares in a mutual fund through a broker. Instead, the insurance company pays the sales commission to the agent. To recoup its investment, and to pay other marketing expenses incurred processing and marketing the annuity, it imposes a surrender charge to encourage you to leave the money in the account for anywhere from four to 13 years. Typically, the surrender charge declines gradually over the surrender charge period.

Taxation of Withdrawals

In exchange for the tax-deferred buildup within an annuity, the annuity owner must pay income taxes on any profits made within the annuity. However, there is no tax due if the annuity owner exchanges one annuity for another annuity, or does the annuity sale within an IRA. The surrender charge period still applies, however, whether the annuity is held in a retirement account or not. You cannot deduct the surrender charge; instead, you are simply not taxed on the surrender charge in the first place. Since the insurance company keeps the money, it is never issued to you as income, and there is no income tax liability.

Bonuses

Some annuity issuers grant bonuses to newly purchased annuities. These bonuses are designed to encourage potential customers to liquidate their old annuities to buy the new ones. Bonuses can offset any annuity surrender charges, resulting in little or no change to the annuity holder's balance. In exchange for the bonus, however, the new annuity-issuing company frequently pays a lower crediting rate, imposes a longer surrender charge period on the annuity or both.

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