Inflation is a reduction in the purchasing power of money. Things become more and more expensive, so each unit of money buys less and less. Some inflation is normal in a booming economy because people can increase their spending faster than the rate at which people can increase the provision of goods and services. Even so, it is very understandable for people to be concerned about it because it eats into their savings. Fortunately, this is a well-known problem, which is why people can look to inflation-protected income for life for a solution.
To understand inflation-protected income for life, people need to understand the difference between a nominal rate of return and a real rate of return. When they receive $100 from a $1,000 investment on an annual basis, they are getting a 10 percent rate of return on an annual basis. This one is called nominal because this would be the figure that is stated upfront. Unfortunately, the value of money lies in the purchasing power of money. Thanks to that, people can figure out what they are really getting by subtracting the inflation rate from this figure. With an inflation rate of 2 percent, the real rate of return on that investment would be a very respectable 8 percent; with an inflation rate of 8 percent, the real rate of return on that investment would be a much lower 2 percent. Inflation-protected income for life works because people can take these factors into consideration when setting these things up.
Having said that, people who are interested in inflation-protected income for life should seek out a financial adviser for their professional expertise and experience. These things are complicated. Furthermore, the rules can see considerable variation from place to place. Combined, this means that people need to know exactly what they are getting into before proceeding further.
What Is an Inflation-Protected Annuity?Inflation-protected annuities are very similar to their regular counterparts. However, their payments are indexed to the inflation rate. This is meant to protect the recipients from reductions in the purchasing power of their money.
There are a couple of issues with inflation-protected annuities. One, a lot of them have caps, meaning that they are meant to protect the recipients from the gradual inflation that tends to happen rather than the hyper-inflation that has been known to happen. Two, inflation protection comes with a cost. This means that people should expect lower payouts in the early periods from inflation-protected annuities than from regular annuities. The difference can be as much as 20 to 30 percent.
Does an Annuity Keep Up With Inflation?By default, annuities will not keep up with inflation. However, inflation-protected annuities will keep up with inflation to a certain extent that is agreed-upon ahead of time. As such, people will need to choose between the two based on their expectations for inflation in the relevant period. This is important because inflation is particularly damaging for people who are on fixed income.
Please note that an inflation-protected annuity isn't the only way that people can mitigate the risk of inflation. Other examples range from dividend-paying stocks to inflation-protected treasury securities. Each option has its own particular upsides and downsides, which is one more reason for people to seek out a professional's opinion on the matter.
How Do Inflation-Protected Bond Funds Work?Bonds are fixed-income securities. In fact, bonds are the most iconic example of fixed-income securities. Inflation is particularly damaging for people who are on fixed incomes, which can be a serious issue for people who like the reliability of bonds compared to the risk of stocks. Fortunately, there is a solution for said individuals in the form of inflation-protected bonds. Generally speaking, the par value of these securities will increase when inflation happens, which in turn, means an increase for the interest calculated based on that par value. Inflation-protected bonds come with their fair share of issues. For example, they are expensive. Similarly, they are more complicated than their regular counterparts. As such, it might be more convenient for people to invest in them through a fund rather than on their own.
Derek.Alfinito@securitesamerica.com | 469-444-7373