A flat annuity check and inflation: how purchasing power erodes

The first check from a level income annuity and the last one are the same number of dollars. The groceries, the electric bill and the insurance premiums they are meant to cover are not the same. That gap is easy to overlook on the day you sign, because the first year looks fine, and it is the reason inflation is the quiet risk in a product whose whole appeal is certainty.

This post follows one hypothetical flat monthly check through twenty years, decade by decade and then year by year, to show how much buying power it loses under three assumed inflation rates. It then looks at what can be done: a cost-of-living increase built into the annuity, a ladder of purchases over time, other income that rises with prices, and spending flexibility. The inflation rates are assumptions chosen for clean arithmetic, not forecasts. Nobody knows the next twenty years of prices.

The setup: a $2,000 monthly check

Say a hypothetical retiree buys a Single premium immediate annuities (SPIAs): how they work that pays $2,000 a month for life, with no increases. That is $24,000 a year. The payment is fixed by contract, which is the point of the product. The retiree's expenses, however, tend to rise with prices.

Two ways to see the erosion:

1. Purchasing power of the check. How much of today's goods the $2,000 would buy in the future. You divide $2,000 by (1 + inflation rate) raised to the number of years.
2. Cost of the same lifestyle. How many dollars it takes in the future to buy what $2,000 buys now. You multiply $2,000 by (1 + inflation rate) raised to the number of years.

They are two views of the same fact. If prices have risen 80% and the check has not moved, the check buys about 55% of what it used to ($1 ÷ $1.80).

Year by year at 3%

Take 3% as the assumed average annual inflation. The factors come from compounding: 1.03 to the fifth power is 1.159, to the tenth 1.344, to the fifteenth 1.558 and to the twentieth 1.806.

At the end of 20 years the check still says $2,000, but it purchases what $1,107 purchases today. That is a loss of about 44.6% of its original buying power ($893 ÷ $2,000). To maintain the same lifestyle the retiree would need $3,612 a month, and the annuity covers $2,000 of it.

What different inflation rates do

Because the effect compounds, the choice of assumption matters. Here are the same 20 years under three rates.

At 2%, the check loses about a third of its buying power over twenty years. At 4%, it loses more than half. The Bureau of Labor Statistics reported that the Consumer Price Index rose 3.4 percent over the 12 months ending August 2026, as noted in the guide on inflation and life insurance: is your coverage shrinking. One year is not a trend, and the period that matters is the one you live through, but it shows that rates near the middle row are not far-fetched.

A timeline of what the erosion feels like

Percentages are abstract. Here is how the same arithmetic might show up for the retiree across time. The household details are invented.

Years 1 to 5: the check seems fine. Prices have risen about 16% at 3%, and the check covers what it covers. Other income or a modest savings draw fills a growing gap. The retiree is probably happy with the purchase, and the early years are when most people judge an annuity.

Years 6 to 10: the gap becomes noticeable. The $2,000 check now buys the equivalent of about $1,488. If the retiree had planned for the annuity to cover the mortgage-free housing costs and utilities, those bills have grown by roughly a third, and the annuity covers less of them. Savings or Social Security are asked to cover more.

Years 11 to 15: the check covers fewer categories. At the 15-year point it buys the equivalent of $1,284, about 64% of what it did. If health costs rise faster than prices generally, which is common at older ages, the household's own inflation may be higher than the headline rate. Spending patterns differ, and a retiree's costs can move differently from the index. This is a reason to test several rates and not just 3%.

Years 16 to 20: the annuity is a smaller part of the budget. At 20 years the check buys the equivalent of $1,107. It is still a large guaranteed floor, and it will continue as long as the retiree lives, but it is no longer the foundation it was. Whether that matters depends on what else supports the household.

The annuity did what it promised. The risk was in how much of the future the promise could cover.

Why a flat check still has uses

None of this means a level payment is a bad idea. The contract guarantees a dollar amount for life regardless of markets, and for many retirees the main danger is running out of money, not losing buying power on part of their income. A level annuity buys the highest starting payment for a given premium, and that higher starting payment is also an advantage: the retiree has more to spend, or to set aside, in the early years.

The trade-off is between a higher check now and a check that holds its value later. Everyone makes that trade, even if they never calculate it. The exercise here is to make the trade visible.

Option 1: pay for a built-in increase

Many insurers offer an income annuity with an annual increase, such as a fixed 2% or 3% a year, or an adjustment tied to the Consumer Price Index. The starting payment is lower, because the insurer pays more in later years. Whether the CPI-linked version is available, and what limits apply, varies by insurer and product, so ask for quotes.

Say that, for the same premium, the level annuity pays $2,000 a month and an alternative with a 3% fixed annual increase pays $1,550 a month to start. These payments are invented, not quotes. Annual amounts are $24,000 and $18,600 in year 1.

The increasing annuity's year n payment is $18,600 × 1.03 to the power (n − 1). For year 10, that is $18,600 × 1.3048 = $24,269. The yearly payment overtakes the level one in year 10.

Total dollars received catch up later. Add up the payments: after 17 years the level annuity has paid $408,000 and the increasing one about $404,800. After 18 years the level one has paid $432,000 and the increasing one about $435,500. So the cumulative break-even is in year 18. Anyone who dies before then received more from the level contract in total dollars, and anyone who lives past it received more from the increasing one, and a lot more by year 25. That is the longevity bet in a different form: the cost-of-living option pays off for long lives and costs something for short ones.

This calculation also ignores the time value of money. A dollar in the early years can be saved or spent, and a dollar received later has been eroded by inflation. An analysis in real terms, which a planner can run, tends to favor the increasing annuity by more than the nominal break-even suggests, if inflation turns out to be near the assumed 3%. If inflation turns out to be lower than the fixed increase, the increasing annuity was the more expensive choice.

Option 2: build an income ladder

Instead of converting a large sum to income on one date, a retiree can buy in stages, for example a portion at 65 and another at 70 or 75. Later purchases are made with later prices and at older ages, when insurers pay more per dollar. This does not index any single check, but it raises total guaranteed income over time and lets you respond to what inflation has actually done. The guide to building an annuity ladder explains how it works, and planning a deferred income annuity start date from 65 to 85 looks at buying income that begins years later.

The cost is that you take the risk of rates moving against you between purchases, and of a change in health or circumstances that makes a later purchase impossible or unattractive.

Option 3: let other income do the inflation work

Social Security benefits receive cost-of-living adjustments, and that matters for how an annuity fits into a household. Suppose the retiree also receives $2,500 a month from Social Security that rises with inflation at the same assumed 3%, and the annuity stays flat at $2,000. This is an illustration, and Social Security's adjustments are set each year and are not guaranteed to match any given inflation measure.

• Total income today: $2,500 + $2,000 = $4,500.
• In 20 years, measured in the buying power of the dollar today: $2,500 (Social Security keeps pace) + $1,107 (annuity) = $3,607.
• Real income relative to today: $3,607 ÷ $4,500 = 80.2%.

The household's buying power is down about 20%, compared with 44.6% for the annuity alone. The more of the household's income that adjusts, the less the flat annuity check matters. A pension with a cost-of-living adjustment has the same effect, and a pension without one is another flat payment. The first step in judging the inflation risk of an annuity is to list every income source and mark which ones adjust.

Option 4: spending flexibility and assets that can grow

Some retirees plan to spend more in the early years and less later, which matches a level check better. Others hold part of their savings in investments that can rise over time, such as a diversified portfolio, and look to that for the growing part of their budget. This carries market risk that the annuity does not. Savings held for later years have to be invested with that tension in mind, and a financial planner can model it.

A MYGA (multi-year guaranteed annuity) or other fixed product held for a short term does not solve inflation, because its return is fixed for the term, but it can provide cash in stages that can be redirected if inflation runs hot.

Testing your own numbers

You can run the same test with your own figures in five steps.

1. Write down the monthly check. Use the quote you were given, for example $2,000.
2. Pick three inflation rates. Use 2%, 3% and 4% as a spread, or a higher one if your own costs tend to rise faster.
3. Choose the years that matter. Ten and twenty years are a good start, plus the age at which you expect to be most dependent on the income.
4. Find the compounding factor. Multiply 1 plus the rate by itself once for each year. Ten years at 3% is 1.03 multiplied by itself ten times, which is about 1.344.
5. Divide the check by the factor. $2,000 ÷ 1.344 is about $1,488. That is what the check buys, measured in current dollars, ten years from now.

Then ask what part of your essential spending the smaller number still covers. Compare it with the same exercise for your other income. If the total still covers essentials with room to spare at the high-inflation rate, the flat check may be adequate. If it does not, you have identified a gap while you still have choices.

One caution about the household's own inflation. The headline index averages spending across many people. A retiree whose costs are weighted toward health care, property taxes or insurance may see a different rate from the average, and some costs, such as a fixed-rate mortgage, do not rise at all. List your own big categories and ask which ones are fixed in dollars and which will rise.

Questions to ask before buying a level annuity

1. What share of essential spending will the annuity cover on day one, and what share in year 20 at 2%, 3% and 4%?
2. Which of my other income sources adjust for inflation, and by how much?
3. What would a version with a 2% or 3% increase, or a CPI-linked version, pay to start, and what is the break-even year?
4. Could I split the purchase across two or three dates?
5. What is my plan for the gap if inflation is higher than expected?

The inflation and your death benefit applies the same compounding to a death benefit, and the annuity payout calculator shows starting payments for different options. For common errors in the whole decision, see mistakes people make when they turn an annuity into income.

Key takeaways

• A level annuity check never changes in dollars, but its buying power falls every year; at 3% inflation, $2,000 a month buys what about $1,107 buys today after 20 years.
• The loss is larger at 4% and smaller at 2%, so test several rates rather than relying on one.
• An annuity with a built-in increase starts lower; in the example it overtook the level check in year 10 and the cumulative total in year 18.
• Other income that adjusts for inflation, such as Social Security, reduces the damage: in the example, the household's real income fell about 20% rather than 44.6%.
• A ladder of purchases and spending flexibility are other tools; none removes the trade between a higher check now and a check that holds its value.