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Ask the expert: Inflation protection

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The question was: Do immediate annuities offer inflation protection features, and if so, how do these features work?

The answer is: Most immediate annuities are fixed in amount. Although a few contracts offer the option of either a fixed amount or an annuity increasing as a set percentage each year (usually no more than 3% – 5%), most do not.

For those that do, the amount of the first year’s annuity payment will be less than that of contracts without this option. The greater the guaranteed annual increase, the lower the initial payment for any amount invested.

The authors are not aware of any contract providing that annuity payments will vary directly with the unknown future fluctuations in the rate of inflation (as measured by an index such as the Consumer Price Index).

Why such a contract has not yet been introduced is a puzzlement.

The authors have heard, repeatedly, that there is no market for these type of products, which seems unpersuasive, given the almost universal recognition of the devastating impact that inflation can have on those living on a fixed income.

To be sure, the first year’s income from an inflation-adjusted annuity–especially an annuity guaranteed for the life of the annuitant–will necessarily be less (possibly, a great deal less) than that guaranteed by an un-indexed product. And it may be that most consumers would not be willing to accept that trade-off.

Nevertheless, in the authors’ opinion at least, a contract offering the purchaser a choice between fixed payments and payments that will keep pace with inflation ought to be attractive.

Source: This is an excerpt from The Annuity Advisor, 2nd edition, by John Olsen, CLU, ChFC, AEP, and Michael E. Kitces, MSFS, CFP, CLU, ChFC. The book was published in 2009 by The National Underwriter Company, Cincinnati, Ohio. See page 187. Learn more about The Annuity Advisor.