One strategy is to put money into immediate annuities in several lumps over time, rather than all at once. That would allow an investor to get the annuity guarantees on some portion of the money while, hopefully, capturing the better returns whenever interest rates rise in the future. The remaining money can be held in cash or, depending on the time frame, placed in an investment that will hopefully grow at a higher rate of return than can be earned in the annuity.
Insurance firms are well aware of the hesitation to commit to an immediate annuity in a low interest-rate environment. So in recent years more have been offering immediate annuities that adjust for inflation.
Some annuities will raise the payout based on changes in the CPI while others offer contracts where the payout is increased by a fixed amount--such as 2% or 3%--every year for life. Some companies offer both options.
There are other variations as well. New York Life, for example, offers an option on its Lifetime Income Annuity that will increase its payout should interest rates rise by more than two percentage points when the policy hits its fifth anniversary.
The trade-off is that insurance companies offer lower initial payouts on annuities with inflation protection. "Every time you transfer a risk to the insurer you have to pay for it," says Kelli Hueler, founder of Hueler Cos., which provides research and quotes on annuities to financial advisors.
This, says Ms. Hueler, is where many annuity investors make a mistake and simply opt for the contract that provides the highest immediate payout.
A couple-68-year-old male and 66-year-old female-could today get an annuity from a highly rated insurer that promises full lifetime payouts of $3,360 per year with a $50,000 investment, according to Hueler. But 20 years from now, if inflation averaged 3% per year, the income stream would be worth about $1,827 in today's dollars.
Look for Flat Payouts
That may not seem like a good deal, but here's how the inflation adjustments can play out: With a rider on the contract to boost the payout by 3% per year, that same annuity pays out only $2,490 the first year, according to Hueler. But in 20 years, the payout from the annuity would be $4,497.
With an annuity that tracks the CPI, the couple would get a payout of roughly $2,280 per year, more than $1,000 per year less than the annuity without any inflation protection. The reason: For the insurer, the unknown of what will happen with the CPI over several decades is a greater risk than knowing that it will pay out an additional 3% per year. That's especially the case if the CPI adjustment isn't capped.