Among all the investment products designed to help you manage your savings throughout your retirement, a single premium immediate annuity (SPIA) is unique. For a given upfront investment amount it offers retirees a guaranteed lifetime stream of payments no matter how long they live. (The italics serve to point out that the promised payments could be reduced or even curtailed in the event of the issuing insurer going bankrupt, although that risk is quite small). The assurance of guaranteed income makes SPIAs very compelling, especially to seniors concerned about running out of money during retirement. Some retirement researchers have referred to them as the ideal retirement funding source.

Unfortunately there are two key attributes that annuities lack that knocks them off that throne. The biggest one is the fact that they are generally not indexed for inflation. In today’s low-inflation world it’s easy to forget that inflation has surged as high as 15% at times, a level that can decimate the buying power of any annuity in a very short time. Even with a benign annual 3% increase, it takes just 24 years for inflation to eat away half the value of an annuity’s payments. There are some SPIAs that do offer predetermined fixed annual increases (with a concomitant reduced initial payout), but that growth rate may not match the true inflation rate over time.

The second negative attribute of annuities is their cost. Since all annuities are sold on commission, many have high costs as compared to other investment choices. In addition those costs can be very hard to ascertain when embedded in rates or as part of surrendering (cancelling) the contract. SPIAs tend to cost less than other types of annuities.

Recently a small handful of SPIAs known as real annuities have appeared on the market. They adjust payouts annually based on the actual inflation rate as measured by the Consumer Price Index for All Urban Consumers (CPI-U). That would seem to address the lack of inflation protection. But are they worth the cost?

David Blanchett, head of retirement research at Morningstar, evaluated an inflation-adjusted SPIA last year to see if the cost justifies the benefit. His conclusion was that at the moment the answer is no. The cost of that particular SPIA was significantly higher than the cost of an equivalent SPIA with a fixed 2% cost of living increase.

To be fair, an insurer is taking on a much bigger risk selling an SPIA with an unknown level of inflation. If the annuity holder lives for a long time the total payouts could turn out to be significantly higher than predicted. Nonetheless that is what insurers are in the business of managing, so it’s somewhat of a surprise that we haven’t seen more of these real annuity products show up.

SPIAs can still be effective even without a real inflation adjustment feature. If you’re worried that the government or the federal reserve will not be able to control inflation throughout your retirement, buying one with a fixed 2% or 3% growth rate should help since inflation rates since 1950 (with the exception of the early 1980s) have been pretty benign. But as yet no annuity comes close to deserving to be called “ideal.” 

Here’s a link to the research: https://www.advisorperspectives.com/articles/2019/05/20/inflation-linked-spias-are-a-bad-deal