An inflation-linked annuity is a financial product that provides regular payments increasing annually with inflation. Unlike fixed annuities paying the same amount yearly, these adjust based on the Consumer Price Index (CPI) to maintain your purchasing power throughout retirement. They offer lower initial payments but growing income to combat inflation's erosion of fixed income.

Payments use the growing annuity formula where each year's payment equals the initial payment multiplied by (1 + inflation rate) raised to the power of (year - 1). The present value calculation discounts all future payments to today's dollars using the discount rate, accounting for both time value of money and inflation growth.

The nominal rate is the stated interest rate without inflation adjustment. The real rate accounts for inflation: Real Rate = [(1 + Nominal Rate) / (1 + Inflation Rate)] - 1. For example, 6% nominal return minus 3% inflation equals approximately 2.9% real return, representing your true purchasing power growth.

Most inflation-linked annuity contracts include a floor provision ensuring payments never fall below the initial amount. However, some contracts allow negative inflation adjustments to reduce future increases. Always review your specific contract terms carefully, as provisions vary significantly between insurers and products.

Inflation-linked annuities provide lower initial payments because the insurer incorporates future payment increases into pricing. The higher total cost reflects guaranteed annual increases. This trade-off benefits long-term retirees who live through significant inflation, but may disadvantage shorter-lived retirees compared to fixed annuities.

Use your expected return from alternative investments or your required rate of return. Conservative retirement planning typically uses 4-6%, reflecting bond yields plus a small equity risk premium. Higher rates (8-10%) reflect aggressive investment assumptions. Your choice significantly impacts results, so consider multiple scenarios with different rates.

Payment timing matters significantly. Annuity due (payments at period beginning) results in higher present value than ordinary annuity (payments at period end) because money received earlier can earn additional returns. The calculator automatically applies the (1 + i) multiplier for annuity due to account for this timing advantage.

Many insurance companies limit annual payment increases to maximum percentages, typically 3-5% regardless of actual inflation. This cap protects insurers from extreme inflation scenarios while still providing meaningful inflation protection. Check your contract for specific caps, as higher caps provide better protection but may result in lower initial payments.

Input your desired initial retirement income, expected lifespan (annuity period), realistic inflation expectations (2-4% typically), and conservative return assumptions (4-6%). Run scenarios with different inputs to understand income outcomes. Compare results with other income sources (Social Security, pensions) to validate your retirement plan is sustainable throughout your lifetime.

The choice depends on your circumstances and inflation expectations. Inflation-linked annuities cost more initially but protect long-term purchasing power through guaranteed increases. Fixed annuities offer simplicity and higher immediate income but lose purchasing power over time. Compare both options: run calculations for both types, project your lifespan, estimate future inflation, then choose based on your priorities and life expectancy.