The real impact of inflation
Consider the various inflation patterns of Australia. Figure 1 shows an annuity which delivers a sum of $10,000 per year throughout one’s life, provides diminishing purchasing power as time passes. 
The inherent risks of escalation
Some types of lifetime income annuities have been developed that provide increasing payments each year which rise by a pre-specified amount, or the Consumer Price Index.
For example, you could purchase an annuity that would start with a reduced initial payment, say $8000 per month, and climb by one per cent to six per cent each year, depending upon the percentage selection at the outset. If a five per cent annual escalation factor was used, after 10 years, you’d receive $13,031 per year (= $8,000 x 1.0510). But even professionally trained economists are not very adept at projecting future inflation beyond a year or two. How then are you supposed to know which escalation rate to select over the next 20-35 years?
By selecting too high of an escalation factor, you’d be foregoing a lot of consumption during the early years and have more to spend than you might need in later years.
Alternatively, if you select too low of an escalation rate, you may quickly have a strained budget.
What matters is your changing needs
There is a useful study that illustrates the changing consumption basket for Australians as they age, and I recommend it for background reading. Nonetheless, your changing needs may not mirror those even of the average ageing population cohort.
Extract from David Babbel and CommInsure whitepaper, Retire Smarter – new strategies towards a comfortable retirement. You can access the paper via our website.
 I fully recognise that $10,000 per year won’t get you very far in retirement, but the numbers shown can be multiplied to whatever level you need. For example, if you require $60,000 per year during retirement, merely multiply all of the dollar numbers shown by six.
 The chart begins with 1966 because that’s when decimal current was introduced in Australia, which simplifies the calculation.
 Before retirement, your continuing income and the luxury of time can help cushion some bad choices, but after retirement, you don’t have that cushion. It becomes increasingly difficult after a few years of retirement to re-enter the workforce for three to five years to make up for a risky investment that winds up a losing gamble.
 “Spending patterns of retirees as they age – the needs of older retirees.” Association of Superannuation Funds of Australia, July 2011.
General advice only. This material has been prepared without taking into consideration your personal objectives, financial situation or needs. Before acting on this advice, you should consider whether it is appropriate for you. You should read the relevant Product Disclosure Statement before making a decision to buy or continue to hold a product. The Colonial Mutual Life Assurance Society AFSL 235035.