Many millions of Americans depend on fixed annuities to deliver them with the two important aspects they need: keeping their principal secure and deferring taxes. Yet others rely on the third aspect - lifetime annuity interest. The major disadvantage that is built-in to the majority of fixed annuity products is lack of ability to keep pace with the rising cost of living as fixed annuity payments are fixed.
As an illustration, let us assume that you are making a $200,000 deposit in a single premium immediate fixed annuity product. The annuity company you select, using their then-current annuity interest tables, comes with a contract that will then pay out $1,306 per month, or $15,672 in a year. The issue is, if one presumes a 3 percent annual rate of rising cost of living, the purchasing power of your annuity income from these payments will be lower every succeeding year. That is, $15,672 will never be sufficient in the future to buy everything that you can buy with it now.
To defeat this challenge, owners of annuities can decide to buy a cost-of-living rider on their annuity commitment. This rider aims to ensure the income paid by the annuity company increases to keep up with the rate of the cost of living in the long term. For instance, an immediate annuity agreement for $200,000 with a 3 percent the cost of living protection rider will pay merely $1,000 per month to start. Even so, the payment will go up 3 percent each year, thereby supplying a measure of protection in opposition to inflation. The catch is obvious; the expense of the rider reduces the preliminary monthly payment by $306 as compared to the payment made on a contract devoid of the COLA rider. Thus, the inflation protection comes at the cost of lower initial annuity interest. Of course, the annuitant benefits in the long term. Some one who lifestyles for 20 years from the start from the payments would see the monthly payment rise to $1802, that is $498 more per month than what they'd receive from an annuity interest with out a COLA rider.
So the issue for each investor is deciding if they will live ling enough to benefit bu the larger payments in the future. if unsure, you could split the hypothetical $200,000 investment into one annuity for $100,000 with the COLA rider and another annuity for $100,00 without the COLA rider.
Each company offering annuity interest inflation protection their product differently. Consequently, COLA riders too differ in their forms. While some COLA riders are priced as an extra investment, others (like the one discussed above) modify the monthly annuity interest provided. One can possibly also choose from a range of rates regarding annuity payment increase, based on the desired level of inflation protection. For instance, anything discussed above can also be obtained using 6 percent COLA rider. This will make payout at the beginning of the annuitization period proportionately lower, with a higher annuity interest and payments towards the end of the annuity term.