What a participation rate really means

A fixed indexed annuity can credit interest based on how a market index performs. But you usually don't get all of the index's gain.

One of the terms that decides how much you get is the participation rate. Here is what it means, in simple terms.

A quick look at fixed indexed annuities

A fixed indexed annuity is a contract with an insurance company. The interest it credits is tied in part to a benchmark index, such as a stock index, measured over a set term.

If the index goes down over that term, no index interest is added for that period. This floor keeps index losses from reducing your balance.

That floor protects against index losses only. Surrender charges and rider fees can still lower your value.

What the participation rate is

The participation rate is the percentage of the index's gain that is used to figure your interest. It is set by the insurer and is often less than 100%.

For example, say the index rises 10% over a crediting period. With a 50% participation rate, your credit would be based on 5%.

With a 100% participation rate, your credit would be based on the full 10%. The rate may be set for one year or for a longer stretch, depending on the contract.

How caps and spreads fit in

The participation rate is often only one piece. Many products also use other limits.

• Cap: The most interest you can be credited in a period. For example, with a 6% cap, a 10% index gain would be credited at 6%.
• Spread: A percentage taken off the index gain before interest is credited, sometimes called a margin or asset fee. For example, with a 2% spread, a 10% gain would be credited at 8%.
• Participation rate: The share of the gain that counts, as shown above.

A product may use one of these or a mix of them. Similar terms show up in indexed universal life insurance, which we cover in how IUL caps and floors work.

Dividends are usually left out when the index gain is measured. That means your credit is often based on price changes only.

Can the participation rate change?

In many cases, yes. The insurer may be able to change participation rates or caps over time, which could lower your return.

Ask how and when the rate can change. Also ask whether the contract sets any limits on those changes.

What to ask before you choose

A few questions can make the terms clearer.

• What is the participation rate, and is there also a cap or spread?
• How long is each crediting period?
• How can the rate change, and are there any limits?
• Which index is used, and does it include dividends?
• Are there fees for any riders, such as an income rider?

Remember that fixed indexed annuities are not FDIC-insured. Their guarantees depend on the claims-paying ability of the issuing insurer.

Growth is tax-deferred, and withdrawals of earnings are taxed as ordinary income. Withdrawals before age 59½ may also face a 10% IRS penalty.

To learn more, visit our fixed indexed annuity page.

Common questions

Is a higher participation rate always better?

Not always. A product with a higher participation rate may also have a lower cap or a spread, so compare the full crediting method.

What is the difference between a participation rate and a cap?

A participation rate sets the share of the index gain that counts. A cap sets the most interest you can be credited in a period, and some products use both.

Bottom line

The participation rate tells you how much of an index's gain counts toward your interest. It's important, but it works together with caps, spreads and other terms.

Looking at the full picture helps you set fair expectations. Our team can help you compare options and understand the trade-offs.

Have questions about your situation? Book a complimentary call with our team.

This article is for general education only and isn't financial, tax or legal advice. Product features vary by carrier and state. Talk with a licensed professional about your situation.