Many millions of Americans depend on immediate annuities to deliver them with the twin advantages of keeping their principal secure and deferring taxes. The major disadvantage of immediate annuities is that those secure fixed payments never rise and therefore do not keep pace with inflation.
For example, let us assume that you are depositing $100,000 in a single premium immediate annuity. One major carrier currently provides a contract that will provide annuity payments of $658.59 per month, or $7,903 in a year. The issue is, if one experiences a 3 percent annual rise in the cost of living, the purchasing power of the income from these payments will be lower every single succeeding year.
To defeat this challenge, owners of fixed immediate annuities can opt to buy a cost-of-living rider on their annuity agreement. This rider aims to ensure the income paid by the annuity rises to keep up with the rate of rising cost of living in the long term. For instance, an immediate annuity of $100,000 with a 3 percent rising cost of living protection rider will pay $499.06 per month to start out. The payment will go up by 3 percent each year, thereby supplying a measure of protection from inflation. The catch is obvious; the price tag of the rider reduces the preliminary monthly payment by $159.53 as compared to the payment made on a contract with no COLA rider. Some one who lives for 20 years from the start from the payments would see the monthly payment rise to $901.36, that is, $242 more per month than what they might receive from an immediate annuity without a COLA rider.
Each company offering fixed immediate annuities designs their product differently. Therefore, COLA riders also vary in their forms. While some are priced as an extra premium paid (with no reduction in the initial annuity payments), others (for example the one discussed above) have a lower monthly amount paid out in the beginning. You can also choose from a range of rates associated with increase, based on the desired amount of inflation protection. For instance, rather than have 3% annual protection, one could select a 6 percent inflation rider option.
Be aware that it is not possible for fixed immediate annuities to be exchanged for value. The income, less the exclusion amount, is taxed in the same manner as ordinary income. All guarantees should be looked as based on the ability of the company providing the insurance to pay claims. Fixed immediate annuities are classified as long-term investments. One should be aware that your COLA rider does not promise that payments will cover inflation.