Many millions of Americans depend on fixed annuities to deliver them with the twin advantages of keeping their principal safe and sound and deferring taxes. The major disadvantage that is built-in to the majority of fixed annuity products is the lack of ability to keep pace with inflation in the long term. Retirement annuities with COLA Riders are a possible solution.
For example, let us suppose that you place $100,000 in a single premium immediate fixed annuity product. One major carrier currently supplies a contract that will pay you $658 per month, or $7,903 in a year. The issue is, if one presumes a 3 percent rate of rising prices, the purchasing power of the income from these payments will be lower each and every succeeding year. That is, $7,903 will never be sufficient in the future to buy all of that you can buy with it now. (In twenty years, $7,903 is like having only $4,375).
To get over this challenge, owners of retirement annuities can decide to buy a cost-of-living rider on their annuity policy. This rider provides that the income paid by the annuity raises to keep up with the rate of rising prices in the long term. For instance, a retirement annuity for $100,000 with a 3 percent rising cost of living protection rider will pay $499 per month the first year (rather than the annuity in the previous paragraph which pays $658 monthly and has no COLA rider). Nonetheless, the payment will go up by 3 percent each year, thereby supplying a measure of protection versus inflation. The catch is obvious; the price of the rider reduces the original monthly payment by $159 in comparison to the payment made on a contract with no COLA rider. The annuitant benefits in the long term, however. After 20 years from the start in the payments, our investor with the COLA rider would see the monthly payment climb to $901, that is, $242 more per month than what they'd receive from a retirement annuity without a COLA rider.
Each company offering retirement annuities with COLA riders structures their rider differently. While one annuity company may simply charge a on-time advance fee for the rider, others (including the one discussed above) customize the monthly amount paid out by starting smaller and then rising over time. You can also choose from a range of rates involving the annuity payments increase, based on the desired amount of inflation protection. For instance, the illustration provided above can also be obtained for a 6 percent inflation rider.
Observe that it is not possible for retirement annuity to be gave up for value after payment begin. Income derived from annuitization (retirement annuity payments) is recognized as part ordinary income and part return of principal. All guarantees are based on the ability of the company supplying the insurance to pay claims. Retirement annuities are classified as long-term, illiquid investments. One should be aware that the actual COLA rider does not promise that payments will cover inflation.