How To Choose Inflation-adjusted Annuities For Your Retirement
What starts out as a seed during your working years goes on to become your income during retirement. This is your savings portfolio, and it grows because of dollar cost averaging the power of compound interest, and your regular contributions. But what happens when you retire?
They say that money doesn’t grow on trees, but if you could turn your portfolio into a perpetually giving tree, wouldn’t you want to know how? Annuities are one way to structure your portfolio for lifetime income, but if you plan carefully, they can also give you a pay raise during retirement so that your income continues to grow. Here is what you need to know about inflation-annuities.
WHY DO YOU NEED TO WORRY ABOUT INFLATION?
Today’s investors are retiring during a time when one in five people can expect to live beyond their 90th birthday. Americans, in general, are enjoying longer life expectancies and greater health, and the world’s population of centenarians is projected to reach the 3.7 million mark come 2050. Obviously, the longer you live, the more money you’ll spend, and the more you’ll see the price of things go up.
Consider this: the cost of a new car in 1955 was around $2,200. In 1985, the average price for a new car rose to $9,005. In 2015, the average cost for a new car was $33,560. How much will prices go up during the time of your retirement?
WHY EVERY PLAN NEEDS A LITTLE COLA
A hundred dollars today won’t buy you the same amount of groceries as the $100 20 years from now. Since 1975, the Social Security Administration has been conducting annual cost-of-living adjustments (COLA) to ensure that the purchasing power of its benefits isn’t eroded by inflation. The amount of the COLA increase is measured by the Consumer Price Index (CPI).
When you are living on a fixed income, the rising cost of basic human essentials means that your quality of life could, over time, go down. This is why every retirement plan needs a little COLA. You want your income stream to have an element of COLA built in so that as you age, your income sees an increase in proportion to today’s economic environment of rising prices.
CHEAP AND EASY VERSUS COMPLICATED AND MORE EXPENSIVE
The cheapest way to generate an income using an annuity is to avoid using income riders. You can do this by taking advantage of an immediate annuity, but it won’t give you inflation protection. The check will be for the same amount of income year after year for as long as you live.
To get an element of inflation protection built into your income plan, you have two choices for guaranteed payments that increase over time: 1) an indexed annuity, or 2) a variable annuity. These two solutions couldn’t be more different from each other, and they may come with additional fees.
- The indexed annuity is sometimes referred to as an inflation-indexed annuity. It links indirectly to a market index so that it can give you an element of growth that can protect against inflation. You get to choose the market index, and the returns are generally significantly higher than the average annual rate of inflation, currently at 3.22 percent. Indexed annuities do not have fund management fees because they do not directly participate in the stock market, and they offer principal guarantees so that you can’t lose money during times of market decline.
- The variable annuity or variable immediate annuity can also be structured to give you lifetime periodic payments. It gives you an element of growth through direct participation in the stock market. You are restricted as to which investments you can choose, you’ve assessed a fee for the management of these investments, and these investments can lose you money.
HOW TO FIND OUT WHAT YOUR INCOME WILL BE
Both kinds of annuities are often sold with income riders. The income rider can give you additional protection and benefits, but you pay a fee that ranges from .95 percent to as high as 2.25 percent for joint lifetime income on variable annuities. You may also have the option of selecting a fixed percentage increase of, say, 2 or 3 percent versus the full CPI increase.
How do you know which type of annuity can give you the highest income payment over time? This can be difficult for the consumer to figure out because annuity salespeople often offer bonus money, additional features, and guarantees. These perks can make it tempting to choose annuities that actually offer a lower percentage of income payment in exchange for a higher percentage of guaranteed growth. Inflation-indexed annuities typically offer a lower first-year payment that is up to 30 percent less than that of an immediate annuity.
Life insurance companies use your age, life expectancy, and the inflation rate to forecast your exact income payments, so there is no easy way to google the answer to the question, how much income will I get? It is, however, one of the most important questions you can ask your financial advisor.
Before you buy an annuity, make sure you understand how the income will be calculated, how much income you will get, and whether or not that income has an element of COLA built in to give you a pay increase over time. Inflation-adjusted annuities are not sold as separate products, and they aren’t often advertised as such. Depending on your situation, you may not need an inflation-adjusted annuity. Everyone’s financial situation is different, which is why you always want to get a second opinion before committing to any long-term investment.
To find out what your options are for adding an element of inflation protection to your portfolio, reach out to one of our income planning experts. We can shop around and compare different options against each other, or make recommendations about solutions that might be a good fit for you. We are 100 percent independent and are the #1 provider of independent annuity reviews in the nation. If you have an annuity question, we’d like to hear from you! Fill out our simple form or call our hotline at (888) 440-2468.