The steady income generated through annuities can be very attractive. However, if you’re counting on those payouts for a long period of time, you should consider the effect of inflation. Annuity yields are often lower than the inflation rate which means that the value of your money may shrink over time. There are some strategies to protect yourself from this risk.
Inflation-protected annuity accounts and the like: As of late, companies are offering annuity accounts with inflation-adjusted yields. Some raise the payout according to changes in the Consumer Price Index. Others increase payments by a fixed amount– maybe 2-4% — every year for the rest of your life. Some companies offer both options, or some variation. The catch for these accounts versus a regular annuity account is usually a lower initial payout.
Spread out money put into immediate annuities: Make several lump sum deposits into immediate annuities rather than only one. This will allow you to get a guaranteed amount each month and then invest more when interest rates rise to get a better return. In the meantime you can grow your money by putting it into another (higher yield) investment vehicle.
Invest an amount to match inflation: This is an option for those simply want to guarantee a specified amount without going through any added trouble. The Bureau of Labor Statistics offers an Inflation calculator to show the effect of inflation on the dollar over time. If you know how much of a payout you will need each month, you can invest accordingly.
Many investors don’t realize the effect that interest can have on their savings. They may notice that their payouts are no longer covering what it used to. Taking precautions will protect consumers who depend on annuity payouts to pay bills. A fixed or immediate annuity will charge you for taking out money for a specified period of time before the maturity date. Hedging against inflation can help you avoid premature withdrawals that cause hefty Surrender charges, a 10% tax penalty, and a reduced payout.
Some people don’t have to go through the trouble of worrying about inflation protection. If you are getting money from other investments, inflation-adjusted pensions, and/or your bills won’t rise over time, a regular annuity may be all you need. If these apply to you, also consider looking into IRA’s which have considerably lower fees.