How Can Annuities Address Inflation?

Inflation can create a rocky income road. There are Annuity Strategies that can guide the inflation ride.
Inflation can create a rocky income road. There are Annuity Strategies that can guide the inflation ride. By Paul Biris / Moment / Getty Images

Everybody Has a Reasonable Fear of Inflation

The 900-pound gorilla in every financial room and every retirement discussion is the common fear of future inflation. Our beloved government doesn’t really help clarify this when the CPI (Consumer Price Index) calculations do not even include food or gas. If you think about that fact for a second, it’s utterly ridiculous. We all know that gas prices are at unbelievably high levels, and one trip to your local grocery store creates a prime example of inflation in action.

Have you priced peanut butter lately?

Two Types of Inflation-Normal and Hyper Inflation

There are really two types of inflation I think consumers should be aware of and try to plan for.  One is what I refer to as “normal” inflation, which means that inflation is running at a 1 to 3 percent annual clip. The other is what economists call “hyperinflation.” This happens when rising prices are out of control and rising at such a rapid pace that it makes the general definition of inflation almost meaningless. I know that the gold bugs will disagree with me on this, but there is not a product on the planet that can truly address hyperinflation. Good luck with trying to buy bread at your grocery store with gold. It’s just not practical. You can make an effort to contractually combat "normal" inflation using various annuity product strategies.

COLA Riders Can Be Structured so Annuity Payments Increase Yearly

COLA stands for Cost of Living Adjustment.

You can add a COLA rider (i.e. attached benefit) to product types like Single Premium Immediate Annuities (SPIAs) and Longevity Annuities (DIAs – Deferred Income Annuities). Your income stream then increases annually by a percentage you choose at the time of application. For example, you can attach a 3% COLA Rider to an SPIA or DIA and your income stream will increase every year by 3% for the life of the policy.

It’s important to point out that the annuity companies lower the initial payment level when you attach a COLA Rider, so when researching this strategy compare the annuity with and without the COLA attached.

CPI-U Riders also Might Provide for Possible Increased Annuity Payment Levels

CPI stands for Consumer Price Index, and the U stands for Urban Consumers. The CPI-U is a measurement that looks at the changes in price of what the government calls “a basket of goods and services” purchased. Gas and food are typically not included in this calculation, and I feel that political pressures come into play when this number is determined. An annuity with an attached CPI-U Rider has no guarantee that there will be an increase, and typically there is a cap (i.e. limitation) on how much of an annual increase to your income stream you can receive. This is problematic if trying to define future income levels. Similar to attaching COLAs, if you add a CPI-U Rider to a policy, the issuing annuity company will lower the initial payment when compared to the same annuity without a rider.

Small Handful of Indexed Annuities Offer a Non-Guaranteed Payment Increase

I hesitate to even include this category because somehow agents will over-hype and mislead the consumer on how this product actually works.

The bottom line is that there are a handful (less than 5) indexed annuities that offer an attached rider to increase your income stream. That non-guaranteed increase is attached to the limited (i.e. capped) annual index return. As with COLA and CPI-U riders, the initial payment is lowered when compared to a typical indexed annuity payout.

Annuity Strategy to Address Inflation Might Make Sense in Your Portfolio

I always tell people, insurance and annuity companies have the big buildings for a reason. They price their products based on when you are expected to die. It isn't morbid, it's just math. In addition, they don’t give anything away. So when considering annuity strategies to combat inflation, it’s important to run the real math numbers. Compare annuities with and without inflation attachments.

If you have a history of longevity in your family, then adding an inflation rider might make sense for your specific situation.