What seniors should know about inflation and annuities now

The latest inflation data is in, and unfortunately, it comes with more bad news for consumers. The Consumer Price Index data, released today, shows that inflation climbed to 2.9% in August, marking yet another uptick in prices. And Americans are clearly feeling the impact, with two-thirds of consumers reporting in a recent poll that they feel prices are continuing to rise and are likely to continue that trend, a sentiment that hits particularly hard for those living on fixed incomes. 

For seniors who depend on retirement savings and predictable income streams, these inflationary pressures create a unique challenge, one that goes beyond simply paying more at the grocery store. As inflation creeps further away from the Federal Reserve’s 2% target rate, retirees are in a particularly vulnerable position, because as the purchasing power of their dollars continues to erode, they face limited options to increase their income. 

This economic reality may leave some seniors reconsidering their retirement income strategies, with annuities emerging as one potential solution. By purchasing an annuity, retirees can secure a guaranteed income stream for life, but given today’s unusual landscape, there are a few things retirees should know before buying one.

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What seniors should know about inflation and annuities now

Here are three key considerations for seniors who may want to protect their retirement money from the effects of inflation with the help of an annuity:

Inflation can still erode fixed annuity payments over time

Traditional fixed annuities promise a steady stream of income, but that promise comes with a hidden catch: The payments generally stay the same while everything else gets more expensive. So, if you’re receiving $2,000 monthly from a fixed annuity today, that same $2,000 will buy significantly less in 10 or 15 years. With current inflation running at 2.9%, your purchasing power decreases by nearly 3% annually, meaning what costs $100 today will cost about $135 in just 12 years.

This erosion happens gradually, too, which makes it easy to overlook, at least until the impact becomes undeniable. Many seniors who purchased fixed annuities years earlier are now discovering that their seemingly generous monthly payments no longer cover the same expenses they once did. The challenge becomes even more pronounced when you consider that healthcare costs, which consume a disproportionate share of senior budgets, often inflate faster than the general economy.

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Variable and indexed annuities can act as potential inflation hedges

Though they come with increased risk, variable annuities can offer a potential solution to the inflation issue by tying your returns to market performance. When the stock market performs well, your annuity payments can increase, potentially outpacing inflation. However, market downturns can also reduce your income, compounding the problem and leaving you with less money when you need it most.

Indexed annuities are another option, as these annuities attempt to split the difference by linking returns to a market index while providing some downside protection. These products typically offer a minimum guaranteed return while capping potential gains. So, while they won’t capture the full upside of a bull market, they can provide some protection against inflation without exposing you to the full volatility of direct market investment. The trade-off, though, is complexity. Indexed annuities often come with intricate terms and conditions that can be difficult to understand.

Inflation protection riders could be your shield against rising costs

Perhaps the most direct solution for inflation-conscious seniors, though, is adding an inflation protection rider to your annuity contract. These riders automatically increase your payments by a predetermined percentage each year, which typically ranges from 2% to 4%. Some riders even tie increases directly to the Consumer Price Index, ensuring your payments keep pace with actual inflation rather than an arbitrary percentage.

The cost of these riders varies, but they will typically reduce your initial annuity payment in exchange for the future increases. For a 65-year-old, this might mean starting with $1,800 monthly instead of $2,000, but ultimately having payments that grow to $2,400 by age 75 and $3,200 by age 85. While the math looks favorable over time, you need to live long enough to reach the break-even point where the accumulated increases offset the reduced starting amount. So, keep that in mind when weighing your options. 

The bottom line

The current inflationary environment demands that seniors take a more active approach to protecting their retirement income. While annuities can provide valuable income security, not all annuity products are created equal, especially when it comes to inflation protection. Fixed annuities may offer peace of mind in the short term, but they can become a liability over longer retirement periods.

Before making any decisions, carefully evaluate your overall financial situation and options, and make sure you understand the true costs and benefits of different annuities. And, remember that the goal isn’t just to preserve your money. It’s to preserve your purchasing power and maintain your quality of life throughout retirement.