Riders Explained: The Inflation Rider

Summary

We’ve spoken about inflation before. It’s the idea that the price levels of goods and services in the economy increase over time. This increase impacts how much you can get for your dollar, a concept known as your purchasing power. As inflation climbs higher and higher, your purchasing power dips lower and lower. How does this connect to annuities? Inflation affects interest rates, which, in turn, help determine how much your annuity will cost to purchase today. It also affects how much your monthly annuity payouts buy in goods and services. And it may even affect how fast your monthly payout increases So inflation is definitely something you care about.

Inflation is more or less inevitable in the economy. While you can’t avoid it, there are ways to defend yourself from bearing the burdens of decreased purchasing power. Inflation riders protect your annuity income against the reduction in purchasing power brought on by rising economic inflation. In other words, an inflation rider, also known as a cost of living adjustment or COLA, preemptively raises your future annuity income in order to account for the inflation that occurs.

A typical inflation rider has a flat annual increase, such as a 1% increase per year. The range of the annual increase levels offered varies across insurance companies, as well as individual products. Additionally, many insurance companies provide a consumer price index rider, or a CPI rider. The CPI measures changes in the price of a basket of goods and services, and demonstrates this change by showing the current price of the basket, as well as its price in the same period of the previous year. This side-by-side comparison of prices illustrates the change in your purchasing power resulting from inflation.

While inflation riders are a helpful tool for protecting your purchasing power, they have a few considerations of their own. For one thing, inflation riders don’t kick in until you start receiving your annuity income, meaning that the rider won’t cover the deferral period (the time between annuity purchase and the start of annuity income payments). A smart way to approach this stipulation is to incorporate some growth into your future income needs, as to take into account the inflation that will occur over the deferral period. We can help you figure out how much this might be. Another caveat of inflation riders is that with the rider comes an associated cost. It’s important for you to make sure you understand that cost before making any decision.

So what’s the next step, now that you’ve learned a bit more about the annuity process? Consider purchasing your deferred income annuity with a CPI inflation rider (or one with a 2% or 3% rider if CPI is not offered by the insurer you decide to go with). What’s more, you can use our online tools to determine the price of the inflation rider, and, as always, contact us for any questions or for more information.

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