The Annuity Purchase Decision
Derek, 66, is retiring with a pension pot of £240,000 and no dependants. He has mild angina but is otherwise healthy and has a life expectancy the underwriters would treat as slightly impaired. He wants a guaranteed income for life and is risk-averse. His adviser notes that annuity rates have risen recently, that Derek could take 25% tax-free cash (£60,000), and that he has no need for the cash. Derek is tempted by an enhanced annuity but is unsure whether to buy now or wait in case rates rise further.
1. Advise Derek on the key choices: tax-free cash, annuity type, and timing.
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Tax-free cash: taking £60,000 reduces the pot to £180,000 and therefore the income. If he has no need for the cash, taking it purely because it is 'tax-free' is poor value - the money then sits outside the pension and loses its tax-free growth and (on death) its inheritance-tax advantages. He should take only what he needs.
Annuity type: with mild angina he may qualify for an enhanced/impaired-life annuity, which pays more than a standard rate because of his health. He should shop the whole market (open market option) and get medical underwriting from several providers - the difference can be material. A level annuity pays more initially but is eroded by inflation; a RPI/CPI-linked or escalating annuity starts lower but protects purchasing power over a long retirement. Given risk aversion and no dependants, a single-life annuity (no spouse's benefit) maximises income.
Timing: annuity rates are unpredictable; waiting is a gamble. He should not try to time the market. If he wants to defer, he could phase purchases or use drawdown temporarily, but that adds risk he says he does not want. On balance, buying now with an enhanced rate is likely best.
2. What suitability and disclosure points must the adviser document?
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The adviser must record: Derek's objectives (guaranteed lifetime income, no dependants, risk aversion), his health details and the medical underwriting evidence, the cash-flow comparison of taking vs not taking tax-free cash, the open-market comparison of quotes (standard vs enhanced, level vs escalating), and the reasons for the recommendation. Under the FCA's suitability rules the advice must be suitable for the client, and the adviser must explain why alternatives (e.g. drawdown, deferring) were rejected. The client should receive clear disclosure of charges, the irreversibility of an annuity purchase, and the loss of flexibility. A signed suitability report protects both parties.