What is Cost-of-Living Adjustment (COLA)?
A Cost-of-Living Adjustment (COLA) is an annual increase to your annuity income payments designed to offset inflation. Most fixed COLAs raise the payment by a stated percentage each year – commonly 1%, 2%, or 3% – while CPI-linked COLAs adjust based on the actual Consumer Price Index. COLA riders are most often added to SPIAs and lifetime income benefits.
How COLA Riders Affect Income
Adding a COLA reduces the starting payment significantly. A 65-year-old man who buys a $100,000 SPIA might receive $580/month with a level payment, but only $440/month with a 3% annual COLA – a 24% lower starting income. The crossover point typically arrives 12-15 years later, when the COLA-adjusted payment overtakes what the level payment would have been. Whether the trade is worth it depends on your life expectancy and inflation expectations.
COLA vs Inflation Reality
Fixed COLAs (like a flat 2%) won’t keep up with inflation if prices spike. CPI-linked COLAs follow the actual index but typically have caps (5%/year is common). Many advisors prefer to ladder multiple MYGAs at staggered terms instead of paying for a COLA – the ladder lets you reinvest at higher rates if inflation forces them up, while the COLA locks in a fixed rate today.
