Annuity or drawdown for a smoker with a spouse to protect
Mr and Mrs Clarke are 68 and 66. Mr Clarke has £180,000 in a personal pension and no other pension savings. He has state pension of £11,500 a year; his wife has £9,000. He smokes 20 cigarettes a day and takes medication for high blood pressure. He wants a secure income of at least £12,000 a year from the pension and is worried about investment risk. He also wants his wife to have income if he dies first. He has £25,000 in savings. He is considering an annuity but has been told drawdown could be more flexible. He wants to know whether an enhanced annuity is available, whether it should be joint life, and whether he should take the 25% tax-free cash. He has no immediate need for a large lump sum.
1. Recommend whether Mr Clarke should buy an annuity or use drawdown, and what features the annuity should have.
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His priority is secure income, not maximum flexibility. An annuity is the better starting point.
- Enhanced annuity: he smokes 20 a day and has high blood pressure. These are material impairments. An enhanced or impaired-life annuity should produce a higher income than a standard annuity. Obtain quotes from several providers through the open market option.
- Joint life: his wife has a lower state pension. A 50% spouse's pension would give her about £6,000 a year from the annuity plus £9,000 state pension, which may be tight. A 100% spouse's pension is safer but reduces his income. Consider 50% with a 5-year guarantee as a compromise.
- Guarantee: a 5-year guarantee returns the unpaid income if he dies early. It is usually cheap.
- Inflation: a level annuity gives the highest starting income but loses value. RPI linking starts lower. His state pensions are triple-locked, which gives some inflation protection. A level annuity may be acceptable if the starting income meets £12,000.
- Tax-free cash: he has £25,000 savings and no immediate need. Taking 25% would reduce the secure income. Do not take it unless he needs it.
Consider splitting: £140,000 annuity for core income and £40,000 drawdown for flexibility. But the default should be the annuity.
2. Explain how enhanced annuities are underwritten and what medical information will be needed.
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Enhanced annuities are underwritten on health and lifestyle.
- The provider will ask about smoking, alcohol, height and weight, blood pressure, cholesterol, medication and past operations.
- It may request a GP report or a medical examination. It may use a simplified questionnaire for common conditions.
- Smoking 20 a day and treated hypertension are likely to qualify for an enhancement, but the rate depends on severity and control.
- The adviser should obtain quotes from several enhanced providers because underwriting criteria differ.
- Full disclosure is essential. A false answer could invalidate the annuity or lead to a reduced income.
- If his wife has health problems, some providers will enhance a joint life annuity on her life too.
- The client should compare the total income over a reasonable period, not just the headline rate.
The adviser should not assume the first quote is the best.
3. What are the risks of taking the 25% tax-free cash and how should the adviser address them?
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Taking 25% tax-free cash is not automatically right.
- The tax-free lump sum is tax-free, but it is not free money. It comes out of the pension and reduces the fund available to produce income.
- If he takes £45,000 and spends it, his secure income falls. If he invests it, he takes investment risk and may pay tax on the returns.
- He has £25,000 savings already. Unless he has a specific need, such as clearing debt or home adaptations, he should leave the money in the pension.
- Taking tax-free cash alone does not trigger the money purchase annual allowance. Triggering flexible drawdown income would reduce his future allowance to £10,000.
- Buying an annuity with the remaining fund does not trigger the MPAA.
- If he wants to leave money on death, an annuity with value protection or a drawdown plan may be better, but that conflicts with his security priority.
The adviser should document the trade-off and let him decide with full information.