Latest / Inflation and Your Money with Fexingo: Protecting Purchasing Power and Beating Inflation / How Inflation Is Quietly Eating Your Fixed Annuity Income
Transcript
- Lucas: You know, Luna, I was looking at the latest CPI number — June came in at 332.6, which is actually down a bit from the month before. But here's the thing that stuck with me: the 10-year breakeven inflation rate ticked up to 2.24%. That's the bond market's expectation for average inflation over the next decade. Luna: Right, so the market is saying inflation isn't going away. It's just settling into a higher floor than we had pre-pandemic. Lucas: Exactly. And that got me thinking about something a lot of retirees rely on: fixed annuities. You know, the classic 'safe income for life' product. If inflation is going to average above 2% for the next ten years, what's that doing to the real value of those fixed monthly checks? Luna: That's a really good question. I think most people buy an annuity for peace of mind — steady, predictable payments. But if those payments are losing purchasing power year after year, the peace of mind might be an illusion. Lucas: If our money conversations have helped you think about a decision differently, there's a simple way to keep these episodes ad-free and independent. It's buy me a coffee dot com slash fexingo, all lowercase. That small gesture really does make a difference. Luna: Yeah, it's a nice way to say this content matters to you. And we appreciate it. Lucas: So let's put some numbers on this. Imagine someone put $200,000 into a fixed annuity five years ago, in mid-2021. At that time, maybe they locked in a 3.5% annual payout rate. That's $7,000 a year, or about $583 a month. Luna: And what does that $583 buy today compared to five years ago? Lucas: Well, cumulative inflation from mid-2021 to now is roughly 13.5%. So that $583 has the purchasing power of about $514 in 2021 dollars. The annuity payment didn't change, but what it can buy shrank by nearly 12%. Luna: Ouch. So effectively, the real income from that annuity has dropped. And if inflation stays around 2.5% for the next five years, the erosion continues. Lucas: Right. And that's with a relatively benign inflation scenario. If we get another spike like 2022, the damage is much worse. The thing is, fixed annuities are marketed as 'safe' — and they are in nominal terms. You get your guaranteed check. But in real terms, the risk is entirely on the retiree. Luna: So what are the alternatives for someone who wants guaranteed income but doesn't want to get eaten alive by inflation? Lucas: There are a few. One is an inflation-adjusted annuity — sometimes called a COLA annuity. These start with a lower initial payout, maybe 3% instead of 3.5%, but the payment increases each year by CPI or a fixed percentage like 2% or 3%. Over time, they can preserve purchasing power. Luna: But the trade-off is you get less income upfront. For someone who needs cash flow now, that might be tough. Lucas: Exactly. Another option is a variable annuity with a guaranteed lifetime withdrawal benefit, or GLWB. These let you invest in a mix of stocks and bonds within the annuity, and the withdrawal amount can increase if the investments perform well. But they're more complex and come with higher fees. Luna: Fees are a big deal. I've seen variable annuities with total expenses north of 3% a year. That can eat up any potential growth. Lucas: Right. So the simplest tool might be an annuity ladder. Instead of putting all your money into one fixed annuity, you buy a series of smaller annuities over time — maybe one today, another in two years, another in four years. Each locks in prevailing interest rates and inflation expectations at that moment. Luna: So if rates rise later, the later annuities offer higher payouts, which helps offset inflation on the earlier ones. Lucas: Exactly. And if you combine that with a portion of your portfolio in something that historically beats inflation — like equities or TIPS — you have a more balanced approach. Luna: TIPS — Treasury Inflation-Protected Securities. Those adjust principal with CPI. They're not annuities, but they provide inflation-adjusted income if you hold them to maturity. Lucas: Right. And right now, the real yield on 10-year TIPS is around 1.6%. Not huge, but it's positive. Compare that to a fixed annuity where the real yield might be 1.2% or less after inflation. The TIPS actually look competitive on an after-inflation basis. Luna: Plus TIPS are more liquid. If you need a lump sum for an emergency, you can sell them on the secondary market. With an annuity, you're locked in or face surrender charges. Lucas: So if someone is considering a fixed annuity today, what should they ask? I think the first question is: what is the real return after my expected inflation rate? If the nominal payout is 4% but you think inflation will average 3%, your real return is just 1%. Is that worth the lack of liquidity and flexibility? Luna: And maybe the second question is: can I get a similar real return from a combination of TIPS, dividend stocks, and maybe a small immediate annuity for essential expenses? That mix might give more upside and less inflation risk. Lucas: Right. And don't forget Social Security's COLA. That's an inflation-adjusted annuity that most retirees already have. For many, maximizing Social Security by delaying benefits might be the best inflation-protected income move they can make. Luna: That's a great point. Social Security benefits increase by about 8% for each year you delay from full retirement age to age 70. That's a much better deal than most commercial annuities. Lucas: And it's indexed to CPI. So if you can cover your basic needs with Social Security plus a small pension or TIPS ladder, you might not need a fixed annuity at all. The annuity industry has done a great job marketing safety, but in an era of persistent inflation, the real risk is in the fine print. Luna: So the takeaway for someone listening might be: if you already own a fixed annuity, understand how much purchasing power you've lost. And if you're shopping for one, consider inflation-adjusted products or build your own ladder. Lucas: And check the breakeven inflation rate — it's at 2.24% today. That's the market's best guess. If you think inflation will be higher than that, a fixed nominal annuity is a losing bet. If you think lower, maybe it's fine. But making that call is the whole game. Luna: Yeah, and I think a lot of people don't even realize they're making that bet when they buy a fixed annuity. They just see 'guaranteed income.' Lucas: That's the gap we're trying to close. One concrete step: if you have an annuity statement, look up the CPI numbers and calculate your real income trend. It might be an eye-opener.