What Is the Participation Rate in an Annuity?


In a nutshell, the participation rate in an annuity is the portion of the gain in a fixed index annuity that you will be credited with. Your annuity will be credited that portion as interest. Fixed index annuities have benchmark index options into which you can put money so that it can earn interest.

Generally, a fixed index annuity is the only kind of fixed-type annuity that will have participation rates. In this article, we will discuss participation rates in an annuity and how they work.

Annuity Basics

Before diving into participation rates more, it’s good to cover the basics of annuities. An annuity is a contract between someone and a life insurance company. In exchange for that person’s annuity premium, the insurance company makes contractual promises to that person, such as for a guaranteed income stream.

There are five different types of annuities offered in the marketplace today, listed as follows:

  • Fixed annuities – These annuities pay a fixed rate of interest for a fixed period of time.
  • Multi-year guaranteed annuities (MYGAs) – These are a type of fixed annuity that pays guaranteed rates of interest for longer periods of time, such as ten years.
  • Fixed indexed annuities – These annuities guarantee your principal, but your interest earnings are based on an underlying benchmark index linked to the annuity, and as a result that growth can vary.
  • Single-premium immediate annuities (SPIAs) – Also known as immediate annuities, they are funded with a single lump sum and start paying income right away. There is no period of tax-deferred growth.
  • Variable annuities – Variable annuity contracts are the most complex type of annuity. The money inside a variable annuity is invested in mutual fund subaccounts that go up and down in value with the markets. It’s possible to lose money in a variable annuity due to market declines.

What Types of Annuities Have a Participation Rate?

Let’s look more at an annuity with participation rates and how this might be an option for your retirement goals. Participation rates are only found in fixed indexed annuities. They aren’t part of the other four annuity types.

As mentioned, a fixed index annuity has an underlying benchmark index that is used to calculate how much interest is credited. Participation rates are one of a few crediting methods that are part of an indexed annuity.  

Each fixed index annuity product usually has several different benchmarks from which to choose. A common benchmark for most fixed index annuity products is the S&P 500 price index. There are typically other benchmarks as well, and you can split your money up into more than one of them.

How Do Participation Rates Work?

The participation rate in a fixed indexed annuity is expressed as a percentage, such as 40%. This participation rate is always offered with a benchmark index, again such as the S&P 500 price index. The participation rate is “good” for a certain period, such as for a year. That timespan is called the crediting period.

Note that these benchmarks don’t ever include dividends. The premium money is never directly invested in any index or stock market. To make good on its promises to you, the insurance company puts most of your money into fixed-interest investments, such as bonds. Of every dollar of annuity premium, just a few cents are put into call options on the benchmark index that you choose.

So, let’s say you put $100,000 in a fixed indexed annuity and select the S&P 500 price index as your benchmark with a participation rate of 35%. If the index rises by 10% during your first crediting period, then your contract will be credited with 3.5% interest, or $3,500.

Participation rates typically rise and fall in tandem with interest rates. When interest rates are low, then participation rates will drop as well. When rates rise, so do participation rates, at least after a brief time lag.

You may have a set participation rate for one crediting period and then see it change during the following period. Of course, this will affect your overall growth over time, but you are still likely to earn more interest with a fixed index annuity than you would with a fixed annuity.

Participation Rates Don’t Give Limitless Growth Potential

Participation rates are one way that the growth in fixed index annuities is limited. Another growth limit is with a spread, where the first percentage point or two of growth are credited to the insurer before you get anything credited to your contract.

The third limit is called a cap, which is an absolute limit on the amount of growth that may be credited in each crediting period. In some cases, more than one limit may be applied to a specific index option.

For example, one option may give you a 120% par rate with a spread of 2%. So, if you put $100,000 in this bucket and the index grows by 6%, then your money will grow by 7.2%-minus the first two percent from the spread.

Conversely, you may receive all 120% of the index growth but get capped at an 8% maximum possible gain. The trade-off for these limits is the protection against losses when the benchmark index drops in value.

Opportunities for Enhanced Participation Rates

It’s possible for your participation rate to exceed 100% in some cases. But this will almost never be on the S&P 500 price index or other well-known benchmark indices like it. The call options on these benchmarks are higher priced than the options for some niche benchmark indices offered with fixed index annuity products run.

If you do have a choice for a benchmark index with a participation rate over 100%, a fee may be involved. But in some instances, this fee may be worth it. For example, one life insurer recently offered an index choice that charged an annual fee of 1.25%. But for this hefty fee, the contract would pay you a whopping 230% of the index’s growth for that crediting period.

Ask your financial professional about the objective pros and cons of these selections if you are thinking about them for your fixed index annuity.

How Do Surrender Charges Affect Your Annuity?

Virtually all annuities come with a back-end surrender charge schedule. These surrender periods usually go for 3 to 10 years and can last for up to 15 years in some cases.

Some surrender periods last longer than others, so be sure to account for that before buying a specific product. But most annuities will also let you withdraw 5 to 10% of your contract value each year without incurring a surrender charge.

Annuities are a long-term commitment. If you are looking to put away your money for just a couple of years and then spend it, then you should look elsewhere for a more liquid alternative.

Talk with your financial advisor about how much money you need to have available versus how much to put in an annuity. Another thing to keep in mind. While surrender charges aren’t the most loved topic, they are one means by which insurance companies keep their guarantees to you and many other contract holders going strong.

Understanding Annuities, Participation Rates, and Alternatives

Annuities come in many forms. In past decades, there were really only two types of annuities: fixed and variable.

Fixed indexed annuities appeared in the 1990s, promising limited growth with protection against loss risk. These products gained traction among annuity customers.

Fixed index annuities are now one of the most popular annuities today. They are a nice alternative for risk-averse savers to variable annuities and their risk of loss.

One powerful feature of a fixed indexed annuity is that at the end of a given crediting period, the contract resets to where the index is on that day. So, if the index that you chose drops by 20% during your crediting period, then you won’t make any interest, but you won’t lose any money either.

When the crediting period ends, the annuity will reset to the new lower value of the index and start crediting interest from there.

If you were invested in a variable annuity, you would have to wait for your money to come all the way back up to where it was originally before you could earn anything more.

Is an Annuity Right for You?

There are several factors to consider if you are thinking about annuities. The first three questions that must be answered are what your risk tolerance, time horizon, and financial objectives are. If you want to save for retirement or turn your savings into a retirement income stream, then an annuity can be a good choice in many cases.

If you need liquidity, then an annuity may not be appropriate. Annuities do have one key advantage: there is no IRS tax limit on how much you can put in them, provided you aren’t using IRA or qualified money to buy your contract. The insurance company will typically set a limit, though.

If you are in your 70s and will start required minimum distributions from your retirement accounts, you can do so in an annuity without any surrender charges. Most annuities today are RMD-friendly, so this shouldn’t be a concern.

If retirement is many years away, then a variable annuity may give you the most bang for your buck, because you will have time to make up for market losses. If you are within five to ten years of retirement, then an indexed annuity may make more sense.

If you have retired already and want guaranteed income, then fixed and indexed annuities can provide this. Consult with your financial advisor for more information about annuities and whether they are right for you.

Are you looking for a financial professional to help you with this and other important retirement questions? Many independent and experienced financial professionals are available here at SafeMoney.com to assist you. Get started by visiting our “Find a Financial Professional” section, where you can connect with someone directly for a complimentary, goal-discovery appointment. Should you need a personal referral, please call us at 877.476.9723.

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