Annuity Payments That Can Help Protect You From Inflation
Immediate annuities can provide guaranteed lifetime income. The income rate is guaranteed no matter what happens to the stock markets or interest rates.
While this can be a powerful tool for ensuring your income in retirement and providing you with peace of mind, many people wonder: can annuities protect against inflation?
The good news is that there is a feature you can add to an income annuity—like an immediate annuity or deferred income annuity—that provides some protection from inflationary pressures: Cost-of-Living Adjustments (COLAs).
Below, we’ll explain how COLAs work, important considerations when purchasing one, and how to get and compare guaranteed quotes for a COLA annuity.
How Does a Cost-of-Living Adjustment (COLA) Work?
Adding a COLA to your annuity allows your payments to increase each year by a fixed percentage that you choose.
Here’s how a COLA works:
- You select an annual increase rate (your COLA rate)
- Your initial payment is reduced to account for future increases
- Each contract year, your annuity income increases by this fixed percentage
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How to Choose a COLA Rate
With a COLA annuity, you choose your annual increase rate. While most insurers offer COLA rates between 1% and 5%, some offer rates as high as 10%. Because you choose your annual increase in advance, a COLA does not reflect actual inflation.
These COLA increases to your income are guaranteed by your contract. Each contract year, your annual income will increase by your COLA rate. For most annuities, your COLA compounds, boosting your earning potential over time.
It’s important to remember that the higher the COLA rate, the lower your initial payout rate. Be sure you balance your inflation protection (COLA rate) with your initial income needs. Keep in mind that many retirees expect their expenses to taper down in their later years as they become less active.
How Much Will a COLA Annuity Pay?
This might be the most important question to answer—but it isn’t always straightforward.
To evaluate a COLA annuity properly, you need to compare it with a traditional level-pay annuity. This comparison tells you how much initial income you are sacrificing to get your annual increases.
The easiest way to get and compare COLA quotes is to use our blue annuity calculator on this page. On the next page, simply fill out the form and select the COLA rate you’d like to explore. We will automatically send level-pay annuity quotes along with your COLA quotes, making it easy to compare your options.
You can run quotes as many times as you’d like, allowing you to test different COLA rates and see how they affect your income.
Is a Cost-of-Living Adjustment (COLA) Worth It?
If you’re wondering if a COLA is worth adding to your annuity, we have an article devoted to understanding COLAs and their trade-offs.
The above article evaluates adding COLAs to annuities for a 65-year-old. In summary:
- COLAs decrease your initial payout rate
- The COLA annuity’s payout typically catches up to the level-pay annuity after a little over ten years.
- It often takes close to twenty years for the COLA option to pay out more cumulatively than the level-pay option
What does this mean for you? When you consider a COLA, keep your income priorities in mind.
If you prioritize:
- Highest starting income: A level-pay annuity is usually the better choice
- Purchasing power protection: A COLA annuity offers stronger inflation protection
- Maximum cumulative income: This depends on how long you live. In the short term, a level-pay annuity often wins; over the long term, COLAs tend to provide more cumulative income.
There are also other annuity strategies that address inflation risk like using an annuity ladder or splitting your purchase between a COLA and level-pay annuity.
Need Help Determining If a COLA is Right For You?
If you’d like help determining whether a COLA fits your situation, call our U.S.-based annuity experts at (866) 866-1999. We can walk you through your options and help you decide whether a COLA—or another strategy—best supports your retirement goals.
We’re committed to providing honest answers without sales pressure. Our goal is to help you make the right decision for your needs.
Is a Cost-of-Living Adjustment (COLA) worth it?
It can be, depending on your priorities and how long you live. If you prioritize maximizing your initial payout rate, a COLA is probably not the best choice for you. However, if you want to preserve your purchasing power over time and reduce inflation risk, a COLA can be a valuable feature.
How much do Cost-of-Living Adjustments (COLAs) reduce your initial income?
The reduction depends on several factors, including your age, gender, and chosen COLA rate. These inputs directly affect how your annuity payout is calculated.
Should I add a Cost-of-Living Adjustment (COLA) to my annuity?
If you want your annuity to address inflation risk, a COLA is designed specifically to that end. The trade-off is lower starting income. You can also use other [annuity strategies that address inflation] or rely on other investments outside of your annuity.
Is there an annuity that changes with inflation?
While some insurers once offered CPI-U adjusted annuities—benchmarked to reported inflation—most major carriers have discontinued them. Instead, there are other annuity strategies that address inflation, like annuity ladders and splitting between COLA and level-pay annuities. There are also other inflation-linked investments such as I bonds.
What Cost-of-Living Adjustment (COLA) rate should I choose?
There is no right answer to this. Future inflation is unpredictable. Adding too high of a COLA rate will decrease your initial payout rates more, while adding too small of a COLA rate may not keep up with inflation. Speaking with an annuity expert can help you evaluate how different inflation strategies and COLA rates may perform over your retirement.
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