What's my financial prognosis?

Denise, 62, wants to know how her health problems might affect her finances:

'I was diagnosed with leukaemia shortly after I retired two years ago. As it is in the very early stages, I have not told my family: I want to save them unnecessary worry.

I have an occupational pension of about £8,000 plus a state pension, but I am not sure what to do about two freestanding FSAVCs, one worth £38,000 and the other £12,000. I have not converted them into annuities yet because I know the pension rules are being changed and that annuity rates are low. I am aware that I can get an enhanced annuity rate because of my leukaemia but I am not sure whether it would be better to spend my savings as and when I want and leave the FSAVCs so that they can form part of an inheritance for my children and grandchildren, take the annuities as soon as possible, or wait until the new pension rules come into effect, when I believe I can take 25 per cent cash.

Regarding my health, I am feeling absolutely fine at the moment and have plenty of energy. I could live for 20 more years and die of something else, according to my doctor. On the other hand, an insurance salesman told me that they reckon seven years for leukaemia patients - not the most tactful person you could meet.

At the moment I am working part time and expect to earn about £8,000 this year. I have around £25,000 in savings in Peps and Isas. I also have money set aside from my pension lump sum to pay off an outstanding mort gage of £15,000 in two years' time. My current house was purchased for £150,000 in February 2003. I have an endowment policy with Norwich Union which finishes in 2011, but I am trying to get compensation for that as the final date is nine years after my retirement date. That policy is currently worth about £16,000. It will pay £26,000 on death but was originally projected at £45,000. I have two other small endowment policies against loans, neither of which look like reaching its initial target. I have repaid the loans and now wonder whether it is still worth paying the premiums on these policies.'

First and foremost: enjoy life to the full

I am very sorry to hear about your leukaemia. You are
doing the right thing by taking it into account in your
retirement planning. Your first consideration, though,
should be your own income requirements rather than
the interests of your beneficiaries. Whatever your life
expectancy, it is important that you enjoy your
retirement to the full while you are still in good health.
There is no point in leaving your money invested in
your FSAVCs if your income in inadequate.

Having said that, income does not seem to be your
immediate problem as you are working part time.
Indeed if you did take the annuity now, it would
increase the amount of income tax you pay.

Normally it makes sense to take the tax-free lump sum
from a pension where this is available, even if
maximum income is required. Investing the money in
an ordinary life annuity is more tax efficient: part of the
income from ordinary annuities is treated as a 'return of
capital' by the tax man, which means it is tax-free.
Payments on pension annuities, on the other hand, are
taxed in full as earned income.

If you don't need the income immediately, waiting until
after April 2006 when the pension rules change will
mean you can take a 25 per cent tax-free cash sum
from your FSAVC funds. With your smaller FSAVC,
you may be able to take the whole amount in cash,
less a 20 per cent tax charge on the balance above the
25 per cent tax free sum. This is because after April
2006 the amount deemed to be a 'trivial pension' (and
therefore available as cash) is also being increased
from ?2,500 to ?15,000.

Another potential advantage of waiting until 2006,
points out Dean Mirfin of adviser Key Retirement
Solutions, is that you will be older and may therefore
receive a better annuity rate.

You ask whether it would be better to use up your
other savings before you take your pensions. John
Turton, director of life and pensions at financial adviser
Bestinvest, says this is a sound approach if you are
likely to be liable for inheritance tax on other assets.
He says 'Good succession planning (especially for
someone in poor health) is to take privately held
assets liable to inheritance tax first and the pension
second. Unvested pensions are written under trust and
will pay out inher itance tax free benefits on death
before vesting.' However, it would appear that your
assets may be under the inheritance tax threshold
(?263,000 for 2004-5) so tax may not be an issue for
you.

To help you make a decision about your FSAVCs, you
should approach an independent financial adviser to
check what rate you could get for an 'impaired life
annuity'. These annuities pay out higher amounts to
those with health problems, depending on the extent to
which the actuaries believe they will affect life
expectancy. Peter Quinton, managing director of The
Annuity Bureau, suggests sourcing an impaired life
annuity through a specialist provider such as GE Life,
Just Retirement or Pension Annuity Friendly Society.'

Whenever you decide to buy an annuity 'the major risk
is whether it will pay out enough should death occur
prematurely', says Turton. 'This could be countered
with a guaranteed period or via an alternatively secured
pension from 2006. However, if this is done, the
annuity rate will fall.'

Under current rules you are not required to purchase
an annuity until age 75. Mirfin says: 'If Denise can
manage on her income/pension as it stands it may be
advantageous to put off purchasing the annuity until
she really needs to supplement her income.'

If you decide to delay, it will be mean your FSAVCs
remain invested and can continue growing in a virtually
tax-free environment. However, Mirfin advises you to
check that the charges and investment performance of
your FSAVC providers are competitive. If not, you may
get a better deal by switching to a lower-cost
stakeholder pension.

As regards your mortgage and endowment policies,
you may be better off using your savings to clear your
loan. The advantage of keeping your endowment
policies is that they provide life insurance cover which,
because of your health and age, you would otherwise
find difficult to purchase.

Denise's to-do list

1. If you need extra income, do not put off buying
an annuity for the sake of your beneficiaries.

2. If you wait until 2006, you will be able to take a
25 per cent tax-free cash sum from your FSAVCs
and possibly take the remainder of the small
policy in cash too.

3. If you decide to buy an annuity, seek the help
of an independent financial adviser with
specialist knowledge of impaired-life annuities.

4. If you are going to put off your annuity
purchase until 2006 or later, check that your
FSAVC policies are competitive in terms of cost
and performance.

5. Consider paying off your mortgage.

6. Bear in mind that your existing endowments
are providing you with an element of life
insurance.

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