November 26, 2013

Value of Cost of Living Increase in an Annuity

Fixed immediate annuities are often quoted without any kind of cost of living increase.  However it might be a good idea to buy one with a increase built in to account for inflation in the long term.  I usually use the  website to get quick quotes on fixed immediate annuities but they don't have any options for inflation/COLA increase options on the annuities.

Fidelity has an estimator for fixed immediate annuity payouts.  One nice feature of their estimator is that it also gives an option to get a 2% annual increase for the payments.   I used their calculator and plugged in different ages and tested for single versus joint and with or without the 2% annual increase.

Here are the monthly payouts for an investment of $100,000 comparing different ages for 65, 55 and 45 years old as well as single versus 100% joint survivor and with or without the 2% annual increases :

65 55 45
single $594 $485 $423
single+2% $484 $371 $310
joint  $495 $427 $386
joint + 2% $390 $319 $273

That gives differences in payouts of :

65 55 45
single 19% 24% 27%
joint 21% 25% 29%

A 2% annual increase is worth around 20-30% difference in thee value of the annuity.    A higher cost of living increase would be worth more.


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