Retirement planning often centers on achieving a long-term sense of stability and security. Although Social Security can provide a modest monthly payment, it's often not enough income for most people to comfortably live on. Fortunately, there are many ways to prepare for and live the retirement you dream about.
However, that consistent payment is normally a fixed dollar amount. Over the years, inflation is likely to reduce its value. Thankfully, some contracts provide for inflation-adjusted annuity payments, which can potentially help maintain financial security during unpredictable times. Here are the key details to know about these payments and whether they can suit your individual needs.
What does inflation mean for your retirement?
Regardless of its pace, inflation is critical for retirees to pay attention to. You need to account for it in your long-term plan—if you don't, you could risk losing purchasing power even if your income never falls.
Can annuity payments increase with inflation?
Annuity payments are typically not set up to increase with inflation. Once you start receiving a regular payment, that dollar amount is usually fixed. However, you have a range of options to help you protect yourself from the effects of inflation.
Navigating retirement with annuities
Annuities that grow your assets may offer some inflation protection, but they don't provide true inflation-adjusted payments. These
Fixed annuities. Pay a predetermined rate for a specific length of time. They are safe vehicles for earning interest, but the earnings might not keep up with inflation. Variable annuities. Allow you to invest in markets with a relatively high level of risk. You can choose investments similar to mutual funds; it's possible to experience long-term growth, but you also risk losing money. Fixed indexed annuities. Provide principal protection and have some exposure to market upside, although caps or other mechanisms might limit growth.
Weathering inflationary periods with annuities
Other types of annuities are only intended to create an income stream. These may be more suitable options for providing inflation-adjusted annuity payments:
Single premium immediate annuities(SPIA). Provide a series of payments when you give a lump sum to an insurer. The payments can last for a specific number of years or for your entire life. Deferred income annuities(DIA). Similar to SPIAs but the payments start later—often years after your initial purchase.
With both of these types of income annuities, payments typically don't change over time once they start. Still, you may be able to purchase a contract that includes inflation adjustments for an additional premium. You can work with your financial advisor to determine the option that's right for your unique situation.
How do inflation-adjusted annuity payments work?
Your annuity contract will describe the manner in which inflation adjustments occur. This will likely be either a set level increase or an adjustment based on actual inflation.
This option adjusts your payment by a set percentage each year. You may have some choice in the applied percentage, but somewhere around 3% is common. Your payment will increase by this percentage each year regardless of the actual rate of inflation.
Inflation adjustments may be a valuable component of your income plan, but they do bring an added cost. This cost normally comes in the form of a smaller payment than you would initially receive from a similar annuity without inflation adjustments. Consider this cost, and compare it with the value that inflation-adjusted payments will provide before deciding if it's the right choice for you.
Design a retirement strategy that works for you
Growing your assets and managing risk form the foundation of a strong retirement plan. These actions can help support your standard of living over the coming decades and potentially ensure you're able to enjoy the retirement you've planned for. Contracts that provide inflation-adjusted annuity payments could also play an important role in that plan.
A skilled financial professional can help you design an income strategy that considers all of your available options and provide valuable insight. Speak with a local