Financial shock of widowhood more than doubles under pension system changes

Recent changes to state pensions and trends in private pension provision may make the financial shock of widowhood greater than many couples realise, analysis from LCP has found, with widows facing a 24 per cent fall in their standard of living upon bereavement.

The firm warned that widows could face a "much bigger fall" in standard of living than the past, with provisions for a “derived” pension right, where women could get pensions based on the contributions of a husband, ex-husband or late husband, “largely swept away” with the introduction of a new state pension system in 2016.

This new system focused on ensuring individuals receive a decent state pension in their own right, with women receiving higher state pensions at retirement as a result after this.

However, LCP warned that a widow will generally inherit little to nothing of their late-partner's state pension under the new rules, meaning that her standard of living could fall “much more sharply” than compared to the old rules, when her state pension as a widow would be enhanced.

The impact of this has been compounded by a shift in trends around private pension provision, as LCP also noted that fewer people will reach retirement with substantial defined benefit pensions in the coming years.

Considering this, it explained that although widows may inherit any balance in a defined contribution (DC) pension pot when her husband dies, if he dies later in retirement the pot may have run down to a low level, whilst in the past, pensions often provided generous widow’s pensions.

Analysis by the firm has also highlighted the monetary impact of these changes, estimating that a “traditional couple” under the old system would see the woman’s standard of living drop by around 9 per cent when her husband dies.

In contrast, a woman under the new system can expect to experience a fall of more than double this when her husband dies, with LCP estimating a 24 per cent fall in their standard of living after a bereavement.

In light of this, the firm has urged recently-retired couples and those approaching retirement to check their position and make sure they are better prepared, clarifying that whilst similar issues affect widowers, they are more likely than widows to have larger pension provisions of their own to support them.

LCP partner, Steve Webb, commented: “Coping with bereavement is hard enough, but coping with a sharp fall in living standards thereafter is even tougher.

“Although the new state pension generally pays more to women in their own right at retirement than the old system, it has very limited provision for widows and widowers.

“Newly retired couples and those coming up to retirement need to find out where they would stand with state and private pensions if one of them were to die and to explore making additional provision to cushion the financial impact of bereavement”.

Personal finance expert, Claire Walsh, added: “Bereavement, particularly when unexpected, is challenging enough so I’d encourage both parties to be prepared and have an understanding of all their assets and incomes and what will happen on eithers’ death so that you each have a plan.

“In shock and haste one could make rash decisions. For example, many people automatically apply to take inherited personal pensions as a lump sum, but it might make more sense to transfer this to a pension in your name and draw from this to provide an on-going income.

“Both options are generally tax free if the deceased was under 75. If the deceased was over 75, the inheriting spouse will pay income tax on the pension, so taking it all in one tax year you could lose much more to tax than by spreading it across multiple tax years.

“Furthermore, by keeping it in pension the money can remain invested and benefit from tax free growth. As pensions sit outside of estates, if you have other investments or cash savings, it may make more sense to draw from these first and leave the pension which could be inherited by future generations."

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