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 CPI-U vs Fixed Percentage amount COLA?



After Income selection date you have an option to include Cost-of-Living Adjustments or COLA rider. COLA is an annual increase in payments which can come in the form of a fixed annual increase from 1% to 5% or linked to an annual inflation index such as the CPI-U just like your social security income increases.  This increase ensure that the purchasing power of income is not eroded by inflation which is running historically under 3% per year for the last ten years.


By selecting your annual increase, CPI-U or Fixed percentage, at application your longevity annuity income payments start off lower when selecting the COLA option.  Example:  Male age 70 deposits $50,000 into a longevity annuity and selects to start income in ten years at age 80 without COLA option.  His annual income payment at age 80 will be $10,820 per year fixed until his death.  If he selected the COLA 3% annual increase option at age 80 the first years payment would start off lower at $9,142 in the first year but increase every year by 3% compounded.  The total income received “break even” is in year twelve where total payments received equal each other.  The COLA 3% increase will give more total dollars of income from year twelve on in this example.


The most common choice would be just give me the CPI-U index option as that will always rise my income payments without a cap or ceiling like in was the 1970's again.  That is not how it works with the CPI-U option in longevity annuities.  Let look at the example below.



























In year three CPI-U was negative and the calculation for income payments was reduced to the floor.  The floor would be the lowest income payment during the start of the QLAC; usually the first payment.  In the above example the average annual inflation (CPI-U) for the ten year period was 3.28%.  If you where to take a constant 3.28% annually your income payments in year 10 would actually be almost 1% higher because there are no negative years in that calculation!  This concept is very important to understand.   It is not always the better options to take a inflation adjustment off of an index like the CPI versus a constant fixed annual increase.  Currently American General AIG American Pathway DIA has the CPI-U inflation adjustment option.



CPI-U: Consumer Price Index for Urban Consumers


This index is was created by the Bureau of Labor Statistics to measure the urban population change in a set group of consumer goods.  The groups include:




APPAREL (men's and women's, jewelry)


MEDICAL CARE (prescription drugs and medical supplies, physicians' services, eye care, hospital services)



OTHER GOODS AND SERVICES (tobacco and smoking products, personal services, funeral expenses).






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