An inflation-protected annuity is a type of annuity that has been designed to provide inflation protection. This means it will increase in value as inflation rises, so you can be sure your retirement income will keep up with inflation. In addition, an inflation-protected annuity provides guaranteed lifetime income for the person who purchased it and may also include an additional death benefit for beneficiaries. Read on to find out more about how annuity inflation protection works!
What is an Annuity?
An annuity is a financial product that provides regular income payments to an individual in exchange for a lump sum payment or a series of payments. Annuities are often used to save for retirement and ensure a steady stream of income in the future.
What Is an Inflation-Protected Annuity (IPA)?
An inflation-protected annuity (IPA) is an investment that guarantees a real rate of return above the inflation rate. This means that the real rate of return is not less than the inflation rate.
Inflation-protected annuities are becoming more popular for people who are afraid of inflation. They will lose money as they age because the prices will increase. These annuities are one way that people save for retirement.
Other Names For Inflation-Protected Annuities
- Inflation-Indexed Annuity
- Cost of Living Adjustment (COLA) Annuity
- Increasing Income Annuities
How Inflation-Protected Annuities Work
An annuity is a contract between an insurance company and a client. The client contributes to the annuity, and the insurance company agrees to provide a guaranteed income stream.
An annuity with inflation protection refers to the guaranteed stream of income that increases over time to keep up with inflation. Payments are indexed to the rate of inflation.
Fixed Immediate Annuities
A fixed immediate annuity provides a lifetime income, regardless of its cash value. This is because the insurance company guarantees to provide monthly payments on a set schedule for life. After that, the payments increase based on a pre-determined annual rate or the declared inflation rate each year.
Fixed immediate annuities are not an excellent longevity hedge because the annuity owner gives up control of their savings with little to no liquidity in case of emergencies. In addition, because there is no cash value, the annuity does not earn interest either.
Inflation-Indexed Annuity
Also called an inflation-protected annuity, an inflation-indexed annuity (fixed indexed annuity) guarantees of stream of income from the insurance company for the rest of your life. The difference is that the payments increase each year based on the consumer price index (CPI) or the performance of a stock market index, keeping pace with the inflation rate. Once the income increases, the payment amount can not decrease from that point forward.
An inflation-indexed annuity is a better option to hedge against longevity, offering the option to cancel the annuity, regular liquidity, the ability to earn moderate interest, principal protection, and enhancement to help pay for long-term care expenses.
Benefits of an Inflation-Protected Annuity
The primary benefit of an inflation-protected annuity is its protection against the negative impact of inflation on retirement income, by linking income payments to a benchmark such as the CPI, the individual’s purchasing power is preserved, even as the cost of living increases.
Another advantage of this type of annuity is the peace of mind it provides. With an inflation-protected annuity, the individual can be confident that their retirement income will be able to keep pace with the rising cost of living, reducing the risk of running out of money in retirement.
Drawbacks of an Inflation-Protected Annuity
One potential drawback of an inflation-protected annuity is that the income payments may not keep pace with the actual inflation rate. This means that the individual’s purchasing power may still be reduced, even though their income from the annuity is increasing.
Another disadvantage is that inflation-protected annuities typically have lower initial income payments than traditional annuities. This means that the individual may need to save more to achieve the same income level in retirement.
Next Steps
Inflation-protected annuities are a valuable solution for individuals looking to protect their retirement income against the negative impact of inflation. By linking income payments to a benchmark such as the CPI, the individual can be confident that their purchasing power will be preserved, even as the cost of living increases. However, it is essential to carefully consider the potential drawbacks and ensure that an inflation-protected annuity is a suitable choice for your retirement savings strategy.
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Frequently Asked Questions
Do fixed annuities protect against inflation?
No, fixed annuities do not protect against inflation. Fixed annuities provide a fixed rate of return on the individual’s investment and do not adjust the income payments based on changes in the cost of living. This means that the purchasing power of the individual’s retirement income may be reduced over time as inflation increases. If protection against inflation is a concern, an inflation-protected annuity may be a better option.
Do annuity payments increase with inflation?
It depends on the type of annuity. Some annuities, such as inflation-protected annuities, are specifically designed to increase income payments over time to keep pace with inflation. The income payments of these annuities are linked to a benchmark, such as the Consumer Price Index (CPI), which measures the change in the cost of living over time. As the cost of living increases, so does the individual’s income from the annuity.