Accounting for Inflation When Buying an Annuity to Cover Essential Expenses

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Jim Saulnier and Chris Stein address a common retirement planning problem: the gap between guaranteed income (Social Security, a pension) and basic living expenses — food, utilities, housing, transportation, health care — tends to grow faster than Social Security's cost-of-living adjustments, because many private pensions have no inflation adjustment at all, and medical costs rise faster than general inflation. Stein says they project this gap growing at 6–9% per year in some client cases, not because expenses themselves inflate that fast, but because the gap between fixed income and rising costs widens. Two strategies exist to handle this. The first is buying an income annuity with a built-in annual payment increase (a contractual COLA), sized to match the projected growth rate of the gap — but adding a large COLA to an annuity substantially raises its cost. The second is laddering: buying a flat (no-increase) annuity now at a lower cost, then purchasing additional annuities later as the gap reappears.

The downside of laddering is that it requires making financial decisions in your late 70s or 80s, when cognitive capacity may have declined. Saulnier recommends reviewing the reserve set aside for future annuity purchases annually — updating for actual inflation experienced, current interest rates, mortality tables, and any changes in life expectancy — rather than assuming a spreadsheet built today will remain accurate for 30 years.