Financial shock of widowhood now greater than many couples realise

Recent changes to state pensions and trends in private pension provision mean that women who lose their husbands could face a much bigger fall in their standard of living than in the past, according to analysis from consultants LCP. Recently-retired couples and those approaching retirement are being urged to check their position and make sure they are better prepared. (Similar issues will also affect widowers, but they are more likely than widows to have larger pensions of their own to support them after a bereavement).

Prior to the introduction of the new state pension in 2016, the state pension system contained an elaborate system of ‘derived’ pension rights where women could get pensions based on the contributions of a husband, ex-husband or late husband. There provisions were largely swept away in 2016 with the new system focused on ensuring that each individual secured a decent state pension in their own right. Many women received higher state pensions at retirement as a result.

However, under the new rules, when a husband dies, his wife will generally inherit little or nothing of his state pension. This means that her standard of living could fall much more sharply when her husband dies than under the old rules where her state pension as a widow would be enhanced.

In addition, in coming years fewer people will reach retirement with substantial final salary pensions. In the past, these pensions often provided generous widow’s pensions when the husband died. But new pension provision is increasingly in the form of ‘pot of money’ or Defined Contribution pensions where there is no ongoing pension. Although the widow may inherit any balance in the pension pot when her husband dies, if he dies later in retirement the pot may have been run down to a low level.

To illustrate this point, LCP have compared the position of a ‘traditional’ couple under the old system, where the husband has the larger state pension and the wife gets a ‘married woman’s pension’, with the position of a newly-retired couple today where both simply get a full state pension in their own right. The research finds that under the old system the woman’s standard of living drops by around 9% when her husband dies, but under the new system her standard of living drops by around 24%.

Commenting, Steve Webb, partner at LCP said:

“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”.

LCP asked three money experts for their tips for couples in this position.

Phil Billlingham, a chartered wealth manager and chartered financial planner at Perceptive Planning, encouraged people to realise how long their retirement finances may need to last and to think what financial products might best provide for a surviving spouse.

Phil said:

“In financial planning we remind a newly retired couple that there is at least an evens chance of one of them living well into their nineties. On that basis it is prudent for a couple to treat all wealth and assets as family assets in retirement and where there is the choice to buy an annuity a joint life annuity should be the default option. Whilst a single life annuity will be the cheapest option, and is usually the first quote you are shown, it does not secure an income for your spouse after you are gone.

Given the risk of an income shock, a relatively cheap option would be to take out a level term assurance policy. For a non-smoking male aged sixty, cover of £100,000 would cost just a pound a day and could be money well spent to provide peace of mind”.

Darren Cooke, a chartered financial planner from Red Circle Financial Planning stressed the importance of being aware of how your income might change if one partner were to die, and of taking steps to reduce the financial pressure on the surviving partner. He also highlighted the potential for using the wealth tied up in the family home to protect the living standard of a widow or widower.

Darren said:

“This is one of those situations where forewarned is forearmed. Just being aware of the change in income if one partner dies allows the couple to plan for it and consider how the widow(er) could cope. In early retirement the couple need to be careful of taking on debt, as even small interest payments could be a big part of a reduced income. Also, be careful of spending down savings too quickly as they may be better spent to support the survivor once the income drops. There is also a need to have a conversation with the wider family, to make them aware that if one person dies the survivor is going to have a significant reduction in income and find out if the family could help out. Finally they could consider the option of equity release, now or after the death, to release funds from the property that could be used to supplement income”.

Claire Walsh, personal finance expert, also encouraged couples to plan ahead and to think carefully before making financial decisions following a bereavement. Claire said:

"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”.

You can read Steve Webb's analysis Do we need to help ‘tomorrow’s widows’ prepare for an income shock? here