Effects of Inflation on an Annuity and Structured Settlement

December 21, 2018

The inflation rate in the US is projected to average 2.40 percent through 2019. This indicates an increase from the 2.1 percent reported in 2017. When these figures are quoted, do you take time to analyze how they affect your annuities? Maybe not, because the insurance company promised you a certain amount regardless of how severe the economic times will be. The truth is that the inflation figures affect your annuities and structured settlements in a big way.

Inflation explained

Inflation is when the value of money doesn’t increase with the price of goods and services. For example, if an item was selling at $2 last year and the price is now $2.5, that’s a 25 percent inflation. It means that with your $2, you can no longer afford that item. Also, it implies that if someone was paying you $2 for a particular task last year, they will, technically, be paying you less if they offer you the $2 today for the same work.

So how does inflation affect your annuities?

Inflation decreases the value of your annuities year to year. We can use an example of someone who receives an annuity of $1000 to illustrate that. If the annual inflation rate is two percent, it means that the price of goods the annuity can buy today will be $1020 next year. The equivalent value of the annuity thus becomes $980. The effect might look little until you think about the impact of cumulative inflation. For instance, what will be the effect of an annual inflation of 2 percent over a period of more than 10 years?

Between 2003 and 2017, the cumulative inflation was about 34 percent. If you were receiving an annuity of $1000 in 2003, the value of the annuity in relation to the price of consumer goods would be about $660 in 2017. From the statistics above, it’s manifest that inflation is one of the factors you need to consider when negotiating your annuities and settlement agreements.

Protecting yourself from inflation

Unscrupulous lawyers and insurance companies will hardly inform you about this inflation trap. But now that you are sharp, you need to let yourself off the trap. One way of doing this is investing in inflation-adjusted annuities and structured settlements. With these annuities, the amount you receive changes with the consumer price index (CPI). The CPI indicates the weighted average of the prices of household consumer goods and services. It is set by the US Department of Labor.

The other means of protecting yourself from inflation is adding an inflation rider to your annuity plan. The inflation rider will adjust your annuity with a simple or compound percentage.

It’s good to note that inflation riders and inflation-adjusted equities and settlement plans do not give you complete immunity against inflation. This is because the adjustment is either based on a pre-agreed rate or the Consumer Price Index. The CPI is an average, and the effect of inflation on your finances largely depends on the products you consume. For example, in a year when the CPI is three percent, you might find that the inflation rate of gasoline is 15 percent. In such a year, if gasoline features prominently on your shopping list, not even inflation-adjusted annuity plans will stop inflation from eroding the value of your annuities.