Issue link: https://resources.envestnet.com/i/1527488
Annuities as an Asset Class for Fee-Based Advisors l 46 © Envestnet 2022 The reality is that the inflation- adjusted spending for many retirees can be expected to decline with age. Meanwhile, the decision about whether the retiree will want inflation protection for the annuity is a different matter. Some worry quite a bit that inflation will be much higher in the future than it is today. The possibility of high inflation would make the inflation-adjusted annuity a more attractive choice. At the present, CPI-adjusted annuities are not available, and having a fixed COLA will not really help with an unexpectedly high inflation rate. If CPI-adjusted annuities were available, the retiree must decide whether it is worth paying the additional cost to obtain contractually protected lifetime inflation-adjusted income beyond what Social Security provides, or whether to instead use a lower initial premium to obtain level income from the annuity. The retiree can then try to manage the inflation risk through the investment portfolio and through the synergies of reducing sequence risk by being able to use a lower distribution rate from the remaining investments. While there is a risk because there is not an asset specifically linked to inflation, my research suggests that the latter approach is generally worthwhile. One additional important point about this discussion is that it has presupposed that retirees desire their overall spending to consistently keep pace with inflation. The reality is that the inflation-adjusted spending for many retirees can be expected to decline with age. Other income sources, such as Social Security, will adjust their benefits with inflation. And as partial annuity strategies mean that only a fraction of overall income is provided by the annuity, it may be the case that an income annuity with level payments will match the spending needs of real retirees more precisely. In other words, having those inflation adjustments may not even be necessary in many cases. If retirees do find that their inflation-adjusted reliable income is falling short of their longevity spending goals, it is always possible to ladder in additional annuities to support more reliable income.