Annuities and Inflation

How are annuities affected by inflation?


Thinking about inflation's impact on an annuity is critical in light of the financial crisis and our current economic environment. There are some comments on this topic throughout the site including this blog post:

Both inflation risk and deflation risk are very real concerns with annuities.

The Federal government has been pumping massive amounts of fiscal and monetary stimulus into the U.S. economy with the hope of addressing the financial crisis. The government has also been assuming enormous amounts of debt through these actions.

Many argue that the actions described above will result in high levels of future inflation.

Inflation affects interest rates and the purchasing power of any annuity payment. Current and future annuity purchasers must incorporate inflation considerations into any decision.

Some initial and high-level considerations when it comes to inflation and annuities are as follows:

1) Buy the inflation protection that comes with certain annuities.

2) Consider variable rather than fixed annuities. The investments that drive annuity contract value and payments may be somewhat effective (e.g. TIPS or inflation protected Treasuries) in off-setting the effects of inflation.

3) Consider holding-off on the decision to annuitize until there is a bit more clarity on the future direction of inflation and interest rates.