Pensions and bereavement: widows and widowers face growing income shock

Surviving spouses can face an income fall of up to 24%, new research suggests. We look at how you can start planning now to avoid a pension income shock.

It goes without saying that losing your other half can be a devastating experience, but it can also have a significant impact on your finances.

This isn’t just the case for families with younger children either, with a new study highlighting the size of the pension shock some older people suffer when their partner passes away.

What happens to the State Pension?

It’s important to highlight that pension reforms have arguably made this situation worse. Let’s start by looking at how things worked before the state pension system was reworked in 2016.

Back then, wives could enjoy a boost to the size of their State Pension based on the National Insurance contributions of their husband or ex-husband.

Now, it’s no secret that this system was far too complex, and too many women slipped through the cracks.

It’s something we’ve covered extensively on loveMONEY, the fact that thousands of women have not received the boosts to which they were entitled.

The Government has started putting that right, setting aside billions in order to top up those State Pensions.

Clearly, the system didn’t always work. But given widows enjoyed a spike in their State Pension after their partner died, there was at least some protection against a massive pension shock in the event of a bereavement.

However, the pension experts at LCP have pointed out that these provisions have largely been removed since the pension reforms introduced in 2016.

On the face of it, this is a good thing, so those reforms focused on helping each individual secure a proper State Pension in their own right, rather than relying on the contributions of their partner, and it has meant that an awful lot of women enjoy healthier State Pensions at retirement.

Yet it’s notable that now, when a husband dies, the wife often inherits little or nothing of his State Pension.

Inevitably, for some, this could mean quite a sharp drop in living standards, sharper than under the old system where the widow would at least see their own State Pension payments increase.

What happens to a private pension?

Of course, the State Pension may only be part of your pension provisions.

Millions of us are now squirrelling cash away each month thanks to the Government’s auto-enrolment scheme, which was designed to get us into the pension saving habit.

However, workplace pensions aren’t exactly a new idea ‒ it’s not that long ago that final salary pensions were commonplace, where you were rewarded for your years of service with a pension payment every year for the rest of your life.

And again, there’s a contrast here that could result in a deeper pension shock for people whose partners die today.

Those final salary pensions often provided the surviving spouse ‒ in many cases, the wife ‒ with a generous regular payment even after the main beneficiary died.

As a result, while the money coming into the household dropped after the husband’s death, the drop wasn’t always severe.

But we don’t really have final salary pensions anymore, with workers instead saving into defined contribution pension schemes.

With these schemes, your eventual pension isn’t based on your years of service, it comes down to the pot of money you’ve managed to save and how long you can make it last.

As a result, when a partner dies, while the surviving partner may inherit what remains of that pot, there is a danger that there won’t be much left.

How big is the pension shock?

So in practical terms, what sort of an income shock are we dealing with here?

As part of its study LCP took the position of a traditional couple under the old system, with a husband enjoying a larger State Pension and the wife receiving a married woman’s pension.

They compared that with the position of a newly-retired couple today where both members are entitled to the full State Pension in their own right.

According to the firm’s calculations, under the old system, the woman would see her standard of living drop around 9%. A blow, yes, but not necessarily a life-changing one.

However, for the modern couple, the surviving partner would see their standard of living drop by around 24%, an enormous shock that would have to lead to some big lifestyle changes.

Guarding against the pension shock

So what can you do about it? There are a few options open to you.

For example, if you are going to purchase an annuity with your pension savings, then a joint annuity means that your surviving partner will still receive payments should you die. That isn’t the case if you each take out individual annuities.

Some financial advisers also suggest considering life insurance.

Yes, the premiums will be more costly if you’re taking out a policy in your 60s, but if you’re looking for a relatively modest sum to supplement existing pension saving, then it may not be too expensive.

Similarly, the way that you handle an inherited pension can make a difference ‒ while some will want to take it as a lump sum, by keeping it invested you at least give it the opportunity to continue to grow.

There are other assets that you might want to call on to supplement your pension income too, like releasing equity from your home.

Ultimately, it’s important to talk about this with your partner before it actually becomes an issue, to work out what options are open to you and how you might go about reducing the income shock that would follow one of you passing away.

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