Cost of Living Riders for Annuities

Cost-of-living riders, also known as inflation riders or COLA riders, provide value protection for annuities. Payments from an annuity with a cost-of-living rider are adjusted automatically to keep pace with inflation and protect your purchasing power.

Annuity providers set the cost-of-living increases for their contracts. They usually calculate increases with movements of the Consumer Price Index (CPI), although, yields on government securities can also play a role.

Choosing a cost-of-living annuity rider protects your annuity payouts from the effects of inflation. With it, your payments will increase based on your insurance company’s cost-of-living index. As the costs of daily necessities rise, so will your payment amounts.

Cost-of-living riders ensure that your annuity payouts don’t lose value. No matter how long you live or how much inflation rises over the years, you should still be able to pay your daily and monthly expenses without sacrificing quantity or quality.

Inflation is the rate at which the cost of consumer goods rises from year to year. In most years, inflation sits at around 2%. A cost-of-living rider increases annuity payouts in response to these rising costs.

Say you receive $1,000 a month from your annuity and use those funds to pay for groceries, utilities and personal care products. If inflation increases the cost of those items by just 2% each year, they will cost $1,218.99 in 10 years.

Without a cost-of-living rider on your annuity, you would still only receive $1,000 a month. You would need to cut back on your purchases or come up with a way to increase your income to meet the elevated level of expense. This is no small feat for many retirees.

Fortunately, with a COLA rider, your payouts rise in step with rising costs.

Cost-of-living adjustments give you more stable buying power for life. You should always have enough money to afford the necessities of life, particularly, food and shelter.

Most cost-of-living riders adjust annuity payouts once a year. How much of an increase you get depends on the index your provider uses to approximate the rise in costs for that year. This means your money won’t lose its value from one year to the next.

The stability in cost-of-living riders stems from the annual increases in payments, which fosters stronger, long-term financial health. Each upward change prevents your retirement income from eroding, giving you confidence and peace of mind as you age.

The advantages of cost-of-living riders are impressive, but they have a few drawbacks that may outweigh the benefits.

Adding a cost-of-living rider shrinks the initial payment generated through an annuity. Moreover, it can take several years for your payout to match what you would have received without a rider. That said, the longer you live, the more the rider pays off.

Some annuity providers limit the frequency of cost-of-living adjustments or cap the size of those adjustments. If inflation rises too quickly or too high, your payouts may fall behind. Check your contract documents for limitations before purchasing a rider and shop around for similar policies with fewer limitations.

Cost-of-living adjustments can also fall behind if you make unscheduled withdrawals during your annuity’s accumulation period. Avoiding withdrawals will keep your annuity growing at a steady pace.

Adding a cost-of-living rider to your annuity provides better inflation protection than forgoing this optional coverage. However, there’s still a chance inflation will outpace your payouts.

Payout adjustments are often based on inflation projection assumptions for the coming year. If the real inflation rate rises higher than your annuity provider’s projection, your payouts may not keep up with actual rising costs.

Cost-of-living riders aren’t for everyone. Purchasing a cost-of-living rider might not make sense for your circumstances. Suitability depends on your goals, income, the terms and conditions of your annuity and other life factors. Before choosing to buy a rider, consider your circumstances carefully and speak to a financial advisor about your retirement income needs.

Here are the key factors that might influence your decision to add a cost-of-living rider to your annuity.