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When Should I Start Taking Money Out of My Annuity?
by
Marco Maknown
•
July 24, 2026
•
18 min
Deciding when to start withdrawing from an annuity is one of those questions that can feel deceptively simple but actually hinges on several moving parts: your age, your tax situation, your other income sources, and the specific terms of your contract. Pull the trigger too early, and you might face surrender charges or miss out on further tax-deferred growth. Wait too long, and you could run into required distribution rules or lose flexibility when you need income most. Below, we’ll walk through the key factors that determine the right timing for you.*
The standard answer: age 59 and a half
Age 59 and a half is the threshold the federal government uses to separate retirement savings from general-purpose money. Withdraw before that age and the IRS treats the distribution as early, adding a 10 percent additional tax on top of whatever income tax is already due. Withdraw after that age and the federal penalty disappears entirely, even though ordinary income tax still applies to any earnings.
Why the IRS sets this threshold
Congress built the 59½ rule into the tax code to keep annuities tied to their intended purpose: long-term income security rather than short-term liquidity. Annuities purchased with pre-tax retirement dollars, and even many funded with after-tax money, receive tax-deferred growth in exchange for an implicit promise that the funds stay invested until retirement age.
According to IRS Publication 575, most distributions from qualified retirement plans and nonqualified annuity contracts made before age 59 and a half are subject to an additional 10 percent tax. The age cutoff is somewhat arbitrary in the sense that no single birthday transforms someone’s financial needs overnight, but it is deliberate in the sense that it discourages dipping into retirement-oriented savings for everyday spending.
The 10 percent penalty explained
The 10 percent penalty is a federal excise tax, not a contract fee, and it applies on top of ordinary income tax owed on the taxable portion of the withdrawal.
- For a nonqualified annuity funded with after-tax dollars, only the earnings portion is taxed and penalized; the original principal comes out tax-free.
- For a qualified annuity held inside an IRA or workplace plan, the entire withdrawal is typically taxable because the contributions were made pre-tax. This penalty is separate from any surrender charge the insurance company itself might impose, which means an early withdrawal during the surrender period can trigger two different costs at once: one from the IRS and one from the carrier.
Exceptions that waive the penalty
The IRS does not apply the 10 percent penalty universally, and several built-in exceptions exist for specific hardships and life stages.
- According to the IRS’s list of exceptions to the early distribution tax, distributions before age 59 and a half are generally subject to the additional tax unless an exception applies, and taxpayers can use Form 5329 to report or claim an exception.
- Common exceptions include death of the contract owner, total and permanent disability, certain unreimbursed medical expenses, IRS levies, and qualified domestic relations orders.
- More recently, SECURE 2.0 added two new exceptions effective January 1, 2024, for emergency personal expense distributions and for victims of domestic abuse, expanding the list of situations where early withdrawals avoid the penalty.
Each exception has its own documentation requirements, so the burden is on the account owner to prove eligibility if the IRS asks.
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Life events that may change the timing
Age 59 and a half is the default rule, but real life rarely follows a default schedule. Retirement, illness, and job loss are the three circumstances most likely to push someone toward an annuity withdrawal before that birthday arrives, and each one carries its own set of tradeoffs.
Retirement and income replacement
Early retirees are the group most likely to need annuity income before the standard age threshold, simply because they have stopped earning a paycheck years ahead of schedule. Someone who retires at 55 has a multi-year gap to bridge before Social Security or pension income begins, and annuity withdrawals can fill that gap.
The tradeoff is straightforward: tapping the annuity early without using one of the IRS exceptions means paying the 10 percent penalty on top of income tax, which can meaningfully shrink the funds meant to last decades. Retirees who anticipate this gap often plan around it years in advance, structuring withdrawals through one of the penalty-avoidance strategies described later in this article.
Medical needs or disability
Medical emergencies do not wait for a 59th birthday, and the tax code recognizes that. Distributions tied to total and permanent disability are exempt from the 10 percent penalty, as are withdrawals used for unreimbursed medical expenses above a certain threshold of adjusted gross income. These exceptions exist precisely because health crises are among the most common reasons people break into retirement savings early. Even with the penalty waived, ordinary income tax still applies to the taxable portion of the withdrawal, so a medical emergency that forces an annuity withdrawal still has tax consequences worth planning for with a tax professional.
Job loss or income disruption
Losing a job is one of the most frequent triggers for an early annuity withdrawal, and it is also one of the situations the tax code addresses only partially. Separation from service after age 55 can avoid the penalty for certain employer-sponsored plans, but that exception does not apply to IRAs or individual annuities purchased outside a workplace plan.
- If you are turning age 55 or older in the year you separate from your company, you can start taking retirement withdrawals from your plan without the 10 percent penalty, though this rule does not apply to withdrawals taken from an IRA at age 55.
- For people younger than 55 or holding an individual annuity rather than a workplace plan, a substantially equal periodic payment strategy, discussed below, is often the more relevant route to penalty-free access during a period of income disruption.
How your annuity type affects timing
The 10 percent IRS penalty is the same regardless of which annuity a person owns, but the practical experience of withdrawing money early is not. Contract structure determines whether funds are even accessible, how quickly they grow, and how steep the insurance company’s own charges will be.
Immediate vs. deferred annuities
- Immediate annuities begin paying out almost right away, typically within a year of purchase, and they are built for income rather than lump-sum access.
- Deferred annuities, by contrast, accumulate value over years before payout begins, and they are the type most associated with surrender charges and early withdrawal penalties because owners are more likely to want money out before the contract matures.
- Annuities like annuitized contracts, deferred income annuities, immediate annuities, and Medicaid annuities generally do not allow withdrawals at all once payments begin, while fixed, indexed, and variable annuities typically do.
Anyone choosing between annuity types should weigh how soon they might need flexible access, because that single decision shapes the withdrawal rules for the life of the contract.
Fixed, variable, and indexed differences
- Fixed annuities guarantee a set interest rate and principal protection.
- Variable annuities tie returns to underlying investment subaccounts.
- Indexed annuities credit interest based on a market index’s performance, usually with a cap.
All three are typically subject to the same IRS rules around age 59 and a half, but their surrender charge structures and growth patterns differ enough to affect the real cost of an early withdrawal. A fixed annuity owner withdrawing early forfeits guaranteed interest; a variable annuity owner withdrawing during a market downturn locks in investment losses on top of any penalty. The IRS treats them identically for penalty purposes, but the financial impact of withdrawing early is not identical across annuity types.
Surrender period restrictions
Surrender charges are a separate cost from the IRS penalty, assessed by the insurance company rather than the federal government, and they apply during a set window after purchase known as the surrender period. As MassMutual explains, most annuities offer a free withdrawal provision that allows a contract owner to withdraw a designated portion of funds, often 10 percent each year, without incurring a surrender charge, though withdrawals will still be subject to ordinary income tax and the additional 10 percent federal tax if taken before age 59 and a half.
Surrender periods commonly run anywhere from three to ten years, and the charge typically starts high in year one and steps down annually until it disappears. This means an owner can be both past the surrender period and still under age 59 and a half, or the reverse, and the two clocks need to be tracked separately when planning a withdrawal.
Tax implications by withdrawal age
Age 59 and a half is the dividing line for the federal penalty, but it is not the only age that matters. A second threshold, age 73, governs when withdrawals become mandatory rather than optional, and the tax treatment shifts meaningfully at each stage.
Before age 59 and a half
Withdrawals taken before this age face both ordinary income tax on the taxable portion and the additional 10 percent penalty, unless an exception applies.
For nonqualified annuities, the tax code applies a last-in-first-out rule, meaning earnings are treated as withdrawn first and taxed at ordinary income rates before any tax-free return of principal occurs. This makes early withdrawals from annuities with substantial gains particularly expensive, since the entire early distribution is often treated as taxable earnings before any principal is touched.
Between 59 and a half and 73
This is the window with the most flexibility. The 10 percent penalty no longer applies, but required minimum distributions have not yet begun, which means owners can withdraw as much or as little as they choose, subject only to ordinary income tax and any remaining surrender charges. Many retirees use these years strategically, drawing down annuity value at a pace that manages their tax bracket rather than taking everything at once. This is also the period when Roth conversions and other tax-planning moves are most commonly layered alongside annuity withdrawals, since income in these years can still be shaped before mandatory distributions begin.
Required minimum distributions at 73 and beyond
At age 73, the rules change again for annuities held inside qualified retirement accounts. Per the IRS’s RMD FAQs, owners of traditional IRA, SEP IRA, and SIMPLE IRA accounts must begin taking required minimum distributions once the account holder reaches age 73, even if they are retired, and they may face stiff penalties for failing to take the correct amount on time.
The required minimum distribution start age rose from 70 and a half to 72 under the original SECURE Act, then SECURE 2.0 pushed it again to 73 for most current retirees, with a further increase to 75 scheduled for those turning 73 after 2032.
Missing an RMD is costly: missed RMD amounts may face a 25 percent excise tax, which can be reduced to 10 percent if corrected within two years. Notably, nonqualified annuities funded with after-tax dollars are not subject to RMD rules at all, since those funds were never tax-deferred contributions in the first place.
Knowing which bucket an annuity falls into, qualified or nonqualified, is essential to understanding whether age 73 will ever apply.
Strategies to withdraw without penalty
For owners who need money before age 59 and a half but do not qualify for one of the IRS hardship exceptions, three structured strategies offer a path to early access without the 10 percent penalty.
72(t) substantially equal periodic payments
Section 72(t) of the tax code allows penalty-free early withdrawals structured as a series of substantially equal periodic payments, commonly called a SEPP or SoSEPP plan. Per the IRS’s guidance on substantially equal periodic payments, if distributions are determined as a series of substantially equal periodic payments over the taxpayer’s life expectancy, the 10 percent additional tax does not apply. Payments must continue for at least five years or until the account owner reaches age 59 and a half, whichever period is longer, and there are three IRS-approved calculation methods:
- The required minimum distribution method
- The fixed amortization method
- The fixed annuitization method
This strategy works, but it is unforgiving. Once a SEPP is established, the taxpayer cannot make any additional contributions to the account or take any payments beyond the scheduled SEPP amount, and changes due to investment experience do not affect that restriction. Modifying the payment schedule early triggers retroactive penalties on every prior distribution, plus interest, so this route demands precise calculation and long-term discipline.
Annuitization options
Converting an annuity’s accumulated value into a stream of guaranteed payments, known as annuitization, is another way some owners access funds without triggering a full surrender or a lump-sum withdrawal penalty. Depending on the contract and the payout method chosen, annuitized payments may be treated differently than discretionary withdrawals for both surrender charge and tax purposes.
Some carriers waive surrender charges entirely once a contract annuitizes, since the insurer is now committed to a structured payout rather than holding funds that could be withdrawn on demand. This option trades flexibility for predictability: once annuitized, most contracts cannot be reversed, so it works best for owners who have already decided they want steady income rather than lump-sum access.
Selling future payments for a lump sum
The types of annuities discussed above are retirement annuities and are subject to different rules than those governing self-owned annuities and structured settlement annuities issued as the result of a personal injury or medical malpractice settlement. If you have a self-owned annuity or structured settlement, then selling some or all the future payment stream to a third party for a discounted lump sum is a path you can take to access your money sooner. The Consumer Financial Protection Bureau warns that dealing with companies offering lump sum payments for structured settlement or annuity payments can be risky, and consumers could receive much less cash than their settlement is worth.
Once a sale is finalized, the seller permanently gives up the right to receive the original payments. The CFPB urges anyone considering this option to talk with a trusted financial counselor or attorney first, compare multiple offers, and confirm that any state-required court approval process is followed. Selling future payments can solve an immediate cash need, but it is a permanent decision that should be weighed against other alternatives.
Should you wait or withdraw now?
There is no universal answer to whether waiting until 59 and a half makes more sense than withdrawing sooner. The right call depends on the cost of the penalty, the rate environment, and what the money would otherwise be doing.
Opportunity cost of waiting
Every year an annuity stays untouched is a year of tax-deferred compounding that an early withdrawal would interrupt. That compounding is real, but it has to be weighed against the actual cost of waiting when a genuine need exists today. A medical bill or income gap left unaddressed can compound its own cost, in the form of high-interest debt or missed obligations, and that cost should be measured against the 10 percent penalty rather than assumed to always be worse. The decision is simple to state and harder to apply: compare what staying invested is likely to earn against what the penalty and taxes will cost if withdrawn now.
Inflation and purchasing power
Inflation erodes the value of a fixed annuity payment over time unless the contract includes a cost-of-living adjustment or inflation rider. Fixed income streams may lose purchasing power over time unless inflation protection is built in, and the need for liquidity becomes a separate concern when prices are rising broadly. This matters for the wait-or-withdraw decision: an annuity payment that looks generous today may buy meaningfully less a decade from now if inflation outpaces the contract’s fixed rate. Owners weighing whether to wait should ask not just how much a withdrawal costs in penalties today, but how much purchasing power a delayed, fixed payment might lose by the time it arrives.
How current rates affect the decision
Interest rates shape what a newly purchased or newly annuitized contract can offer, which indirectly affects the wait-or-withdraw calculus. As financial professionals told CBS News, higher interest rates generally mean strong lifetime income payouts and short fixed-rate periods that often beat CD rates. When rates are elevated, locking in a new contract or annuitizing an existing one can be more attractive than in a low-rate environment, while withdrawing into cash means giving up a comparatively strong guaranteed rate. The decision to wait or withdraw comes back to the same three factors: the penalty before 59 and a half, the surrender charge during the surrender period, and what the current rate environment offers as an alternative.
Frequently asked questions
You will generally owe ordinary income tax on the taxable portion plus an additional 10 percent federal penalty, unless you qualify for an exception such as disability, certain medical expenses, or a 72(t) plan. If you are also within your contract's surrender period, the insurer may add its own charge on top.
Annuities held inside a qualified account, such as an IRA, follow the same RMD rules as other IRA assets, with required withdrawals beginning at age 73. Nonqualified annuities funded with after-tax money are not subject to RMDs at all, since they were never tax-deferred contributions.
Sometimes. The IRS allows exceptions for total and permanent disability, certain unreimbursed medical expenses, and, since 2024, emergency personal expense distributions and domestic abuse victim distributions under SECURE 2.0. Each has specific eligibility requirements, so confirm with a tax professional first.
Most contracts include a free withdrawal provision, commonly up to 10 percent of the account value per year without a surrender charge. This is separate from the IRS's 59½ rule, so a withdrawal can avoid the insurer's charge and still owe the IRS penalty if taken early.
It depends on whether predictable income or flexible access matters more. Annuitizing offers tax and surrender-charge advantages but is usually irreversible, while periodic withdrawals preserve flexibility but keep the full surrender charge and IRS penalty rules in play until the surrender period ends and age 59 and a half is reached.
There’s always JG Wentworth…
Life always finds a way to surprise us—and sometimes, surprises can put an unexpected strain on our finances. For most Americans, the best option in an emergency is to take on debt to cover the expense. Even if you don’t have an emergency—maybe you want to go back to school or put down a payment on a house—it can be difficult to come up with the funds for an immediate need without incurring debt.
But if you have a structured settlement, you have another option available!
Selling part or all of your structured settlement payment stream is a great way to keep your head above water while avoiding taking on extra debt. If you need cash in a pinch to take care of a major expense, this could be the best solution.
Contact JG Wentworth today for your free quote and let’s get your Cash Now!**
SOURCES CITED
- Internal Revenue Service, “Retirement Topics – Exceptions to Tax on Early Distributions.”
- Internal Revenue Service, “Substantially Equal Periodic Payments.”
- Internal Revenue Service, “Retirement Plan and IRA Required Minimum Distributions FAQs.”
- MassMutual, “Understanding Annuity Surrender Charges and Costs” (May 2025).
- Consumer Financial Protection Bureau, “What Should I Know Before Giving Up My Monthly Disability, Personal Injury, or Structured Settlement Payments in Exchange for a One-Time Lump Sum Payment?” (2025).
- CBS News, “Is an Annuity Still Worth It in Today’s Economy? Experts Weigh In” (May 2026).
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*This information is provided for educational and informational purposes only. Such information or materials do not constitute and are not intended to provide legal, accounting, or tax advice and should not be relied on in that respect. We suggest that You consult an attorney, accountant, and/or financial advisor to answer any financial or legal questions.
** Sales of Structured Settlement and Lottery Payments are subject to Court Approval and other conditions which can take 60-90 days to complete. Annuity payment sales are also subject to certain conditions. All transactions are at our sole discretion.
