Question: Inflation is something that worries me going forward. Can fixed annuities actually account for inflation? Is that possible? Eddie M. from Casper, Wyoming
Answer: Great question Eddie, and I agree with you that the real possibility of future inflation is the financial gorilla in the room. I think everyone is concerned about it. Let me start by saying there is not an annuity on the planet that is the perfect solution to combat inflation, and no strategy anywhere can address hyperinflation. However, income annuities do have a couple of effective options that you should at least be aware of.
With some fixed annuity types like Single Premium Immediate Annuities (SPIAs) and Longevity Annuities (Deferred Income Annuities – DIAs), you can contractually attach a rider that will increase your income stream on an annual basis. This increase will happen for the life of the policy, so if you live a long time the numbers do work out in your favor. Let’s take a closer look at these attached benefit riders.
Cost of Living Adjustment (COLA) Rider
With SPIAs and DIAs, the income stream is annuitized, which in essence means that you are creating a stream of payments. You can contractually attach a COLA Rider at the time you fill out the application to annually increase your income stream by whatever percentage you choose. For example, you can attach a COLA Rider to a SPIA or a DIA to increase your income by 3% every year for as long as you live. Some companies even allow you to go as high as 7%. Sounds fantastic, right? So what’s the catch?
As I always say, life insurance and annuity companies have the big buildings for a reason. If you buy the exact same SPIA or DIA with and without a COLA Rider, the policy without a rider will have payments starting at a much higher level. When you attach a COLA, the annuity company will lower the payments to make up for the potential increases. That’s the catch. However, if you have a history of longevity in your family, a COLA Rider might actually make sense and it is important to run comparison numbers so you can see the contractual difference in payouts.
CPI-U (Consumer Price Index) Rider
Just like a COLA Rider, you can also attach a CPI-U Rider that will contractually increase your income annually whenever there is a declared increase in the CPI-U index. If you are currently taking Social Security payments, you are already familiar with this type of increase. One of the limitations of this rider is that you are not guaranteed to receive an increase like you would with a COLA Rider.
Just like with a COLA, when you attach a CPI-U Rider to an annuity policy the payments will be lower than if you bought the same annuity without it. With SPIA and DIA strategies, there are no annual fees even if you attach a COLA or CPI-U rider.
The Best Inflation Annuity on the Planet
The short answer is that you already own it. In fact, everyone owns it. It’s called Social Security. That government income stream functions just like a lifetime annuity payment, and any annual increase is linked to the CPI (Consumer Price Index) and approved by Congress. This works out pretty well because most people that receive Social Security payments are what politicians classify as VOTERS. The majority of the time, even though the country has no money and mountain of unpayable debt, our “popular” politicians usually give their voters a raise. Because of this no rules mentality, in my opinion, Social Security is the best inflation annuity on the planet.
Don’t believe the Hybrid Annuity Hype
Let me just cut to the chase very quickly and warn you to not be sold an indexed annuity (inappropriately called “hybrid annuities” by many unregulated internet promoters) as a product that can increase your payments with inflation. The reason that some agents will try to push the indexed annuity sale is that they will make 2 to 3 times the commission than they would by appropriately and suitably recommending a SPIA or a DIA. Indexed annuities were designed to compete with CD returns (not the market), and their attached income riders shouldn’t be placed in the same COLA or CPI-U categories with SPIAs and DIAs. They just don’t contractually measure up.
The best non-annuity product to address inflation is probably TIPS (Treasury Inflation Protected Securities). My advice is to go to www.treasurydirect.gov and see if TIPS might be what you are looking for. As for annuities and inflation, you now know the truth and can make an informed decision if these strategies would work for your specific situation.
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