The idea behind annuities sounds great. You get a predictable income for the rest of your life no matter how long you live. This frees you from worries about how much you can safely spend each year. Rob Carrick’s recent article covered many important details concerning annuities. However, he left out a very important part of the discussion. The elephant in the room with annuities is inflation.
Canadians like to complain that their CPP (Canada Pension Plan) and OAS (Old Age Security) payments are too small, but at least they are indexed to inflation. Imagine how small these payments would look if they never changed for 25 years.
An ancestor of mine held a senior position and retired decades ago with what was considered to be a very generous pension. However, the payments weren’t indexed to inflation. By the time he died 23 years later, his monthly pension payments had dropped in value by nearly a factor of 3. Take your current income, divide it by 3, and imagine trying to live on the smaller amount.
When you see an annuity quote, it almost never includes any kind of indexing. This makes the payout seem quite good if you don’t think about the erosion of inflation that starts right away. If you get a quote for an annuity with a built-in 3% increase each year, the starting payout is much lower. Even rarer in Canada is an annuity that is indexed to inflation the way CPP and OAS are. Such inflation-indexed annuities have very low starting payouts.
Some common advice is to wait until you’re in your 70s to buy an annuity. The reason given is usually that the starting payout will be higher when you’re older. The more important consideration is that inflation will have less time to erode your payments. However, you would still be taking on the risk that we might have another period of high inflation.
If you’re considering buying an annuity, look into indexed annuities. Anyone who tells you that indexing isn’t important either hasn’t thought it through properly or is trying to deceive you.