(Dow Jones) The guaranteed payouts on immediate annuities offer insurance against the kinds of rocky times investors have been weathering of late. But retirees need to be sure the value of their investment doesn't get slowly whittled away by inflation.
That may mean taking a lower yield on your investment today. But in the long run, it ought to help protect your savings.
Immediate annuities are insurance contracts that convert your cash into a preset stream of income that can last the rest of your life.
Picked Away by Inflation
For many retirees, that sounds especially good against the backdrop of, first, a shaky stock market and, second, concerns that bond yields are so low that whenever interest rates rise--and prices fall--they will be hit with losses.
But low interest rates also are raining on the annuity parade. The reason is that, as the name implies, the payout on an immediate annuity begins shortly after the money is invested. The catch is that payout amounts are highly dependent on the level of interest rates. And right now, interest rates are at all-time lows.
That means what seems a reasonable return today will be worth less and less over time. That's especially the case if there's a meaningful pickup in inflation, something many fear is in the cards for coming years.
The corrosive effect of inflation is hard to see in any given year, but over time its impact can be dramatic. Take a retiree who in 1990 bought an annuity paying out $6,000 per year to help cover essentials in conjunction with his or her Social Security payments. Based on the increase in the consumer price index over the past two decades, that retiree today would be coming up short nearly $4,000 per year.
"You really are locking yourself into a lifetime arrangement," says Scott Witt, a fee-only insurance advisor and actuary in New Berlin, Wis. "Given that we're in a pretty low interest-rate environment, if you lock in your entire amount you might regret it."
There are different ways to tackle this problem, each with its own particular advantages and disadvantages. Deciding which approach makes the most sense will depend on a retiree's overall financial situation and tolerance for risk.