Pensions for widows and widowers could be axed under new rules

elderly women on bench by sea

Widows and widowers could lose their entitlement to payouts from their spouse’s workplace pension under proposals outlined by the government to make final salary schemes more affordable for employers.

Firms have been closing final salary schemes, also known as defined benefit schemes, in recent years as increased life expectancy, high inflation and poor investment performance makes it increasingly expensive to offer a guaranteed payout based on earnings. They have been replaced with defined contribution schemes, where the eventual payout is based on the performance of the underlying investments. These are typically the schemes chosen by employers when auto-enrolling staff into pensions.

At present the government requires private sector employers offering final salary schemes to provide a spouses’ pension on retirement, which amounts to at least half their full pension, along with inflation-linking to guard against the ravages of the rising cost of living.

However, these requirements could end if proposals from the Department for Work and Pensions come into force from April 2014. The DWP report says: “Of course employers could continue to offer schemes that include index-linked benefits and survivor rights if they so choose, but it would no longer be a statutory requirement.”

Employers would also be given the opportunity to move the age at which a worker is allowed to retire on a full pension.

Laith Khalaf, head of corporate research at Hargreaves Lansdown, says: “There’s a big risk that members don’t realise what they’re losing. The proposed changes will make defined benefit schemes more affordable for employers, permitting them to limp along in a reduced form. But the impact of inflation-linking, which is a really valuable benefit, and the peace of mind of a spouses’ pension could be lost.”

He adds: “If a couple are the same age, for example, then statistically the woman will live for three years longer than the man so they will get the financial benefit for three more years. Meanwhile, inflation linking will provide a great financial benefit over the whole period the pension is taken.”

A £10,000 annual pension adds up to £250,000 over 25 years without inflation increases, says Khalaf. It would add up to £351,000 if it rose in line with the current rate of inflation, at 2.7%.

However, any pension built up under current final salary schemes is protected from the proposed changes, which are subject to a six-week consultation.

To encourage businesses to offer pensions with more certainty about payouts, the government has proposed “defined ambition” schemes, which would split the savings risk between workers and their employers.

The costly defined benefit schemes have seen the number of employees in them sink from more than 5 million in 1995 to around 1.7 million today.

A recent report from the Pension Protection Fund and the Pensions Regulator showed that a record 30% of defined benefit pension schemes have closed to existing workers: in 2008, the figure was 17%, rising to 19% in 2009, 21% in 2010, 24% in 2011 and 26% in 2012.