Tens of thousands of retired public sector workers received an unwanted Christmas gift from the government this week - a letter warning them their pensions will be cut from next April.

The reductions are being made after ministers uncovered evidence that overpayments totalling up to £140m had been made for 30 years across a number of schemes including the NHS, teachers, the armed forces, the judiciary and the civil service.

The government is not going to claw back the money but says the "correct" pension payments will be made from April - which means at least 95,000 former public sector workers will have their pensions cut, or increased by less than the value of inflation.

Most of those affected should have received a letter already. If you are not contacted by Christmas, you can assume your pension is in the clear.

The obvious question many people who get a letter will be asking is: How much is my pension going to fall? Unfortunately, it appears it is not possible for the powers-that-be to give any precise answers. More information will be provided in the New Year, as it will vary from person to person.

If you are receiving a widow's or widower's pension, you may be affected. As these are based on the entitlement of the late spouse, those involved will face a lower retirement income.

The overpayments "bill" works out at an average of £1,300 per person or £3.70 a month over that period, but exact amounts will vary depending on when an individual retired and how much they were earning over the years.

It is not known if the problem affects people retiring in every year since 1978 (the year the cock-up dates back to). The scheme administrators, HM Revenue & Customs and the Department for Work and Pensions are still investigating what happened. But it seems likely that the 95,000 are spread across retirement years and salary levels.

The overpayment was first brought to light by the Lib Dems' Treasury spokesman, Vince Cable, in the Commons on Monday. Cable reported he had been in discussion with the cabinet secretary, Gus O'Donnell, about the overpayments made by the privatised company Xafinity. They were "an error of the system" and not Xafinity's fault, says a government source.

Perhaps, not surprisingly, opposition politicians accused ministers of condemning thousands of older people to a Christmas of "uncertainty and fear" after the scale of the problems emerged.

Shadow treasury secretary, Philip Hammond, says it is unacceptable that most of the individuals - some 5% of the total UK public sector pensioners - will not know what their new income is until next year.

"It is completely unacceptable for the government just to tell pensioners they have been affected but refuse to give them the full facts," he adds.

There are fears that many of the could be left struggling to make ends meet, with sharp cuts in interest rates and share values having already reduced their income from savings.

The British pension system is on the cusp of crisis. But how can we tackle a problem that will leave thousands of us living off pitiful sums of money, asks Jon Henley

An unholy combination of government short-sightedness and the all-consuming greed of our great financial services sector means Britain now has the lowest state pension in Europe, while the kind of private company pension scheme into which the vast majority of us are now saving will eventually give us a retirement income typically worth, according to the Pensions Policy Institute, precisely 7% of our salary.

The first state pension was paid out in this country 100 years ago next month. Ever since, the responsibility - and the risk - for the provision of our retirement income has been steadily shifting: from government to employers, and more recently, with the decline of those gold-plated final salary pension systems that our parents' generation enjoyed (and today's public sector workers continue to enjoy), from employers to individuals.

For most of us, the effective privatisation of our pensions means we are obliged to gamble our retirement funds on the stock market, largely for the profit of the legions of bankers, insurers and financial advisers who supposedly manage them. And the sad truth is that the vast majority of us will simply never be able to save enough to provide us with what most people would consider a fair retirement income.

This is a thoroughgoing national scandal. And something very radical will have to be done about it, very soon: from 2012, as the baby boom generation hits retirement age, the number of over-65s in this country is going to go through the roof. Imagine what will happen when they actually try to live on their pitiful pension pots.

So what is the answer? Why do we accept such a shameful excuse for a pension system - and what could, and should, be done about it?

In a famous 50s advert, Pearl Assurance featured a man getting increasingly agitated about his pension as he aged from 20 to 60. If, like most of us, you're in a "personal" scheme rather than a copper-bottomed final-salary plan, the answer to the "how scared should I be?" question is like being stuck on a railway line - it depends on how close the train is or, in this case, how near you are to retirement.

In your 20s

You're 40 or more years away from the official retirement age, due to rise to 68 by 2046 under present plans, with no guarantee that won't rise to 70 or 75. The pensions industry wants you to worry - having fun and a roof over your head are more important right now. But if you're lucky enough to be offered a final-salary scheme, grab it. Fear factor 2/10

In your 30s

Worry a little. You're still a generation away from retirement. But it's still worth paying into a personal pension on a monthly basis - around 5% of your salary. You can afford to take a punt on the assets you buy increasing in value over time - there has never been a 30-year period in the UK when equities underperformed savings accounts. On retirement, your fund will buy an income for life, known as an annuity. Fear factor 4/10

In your 40s

The likelihood is you haven't saved enough and stock market falls mean your pension pot is now worth less than you thought. But few can afford to lock up even more money for retirement - or to take the risks of investing. Your only consolation is to get a forecast of your state pension from the Department of Work and Pensions. If you are an employee with a reasonable salary you might get more than you expect. Fear factor 7/10

In your 50s

Forget retiring at 50 or 55. Prepare to work for years more, and pray for a stock market recovery before you reach 75 - that's the deadline for turning your pension pot into an annuity. Fear factor 9/10

In your 60s

There's very little you can do about falling pension values and miserable annuities - it's probably too late to switch investment strategies. Resenting your contemporaries retiring on final-salary pensions will not help. Planning for a low-income fate will at least help you sleep better.
Fear factor 10/10 for most

What you can do?

If your personal pension is unlikely to provide enough to live on, here are some options:

• Work till you drop. Anti-ageism legislation makes it increasingly hard for bosses to sack you when you reach 65. The older you are when you swap your pension pot for an annuity the better, because the insurance company's calculations assume you won't live so long.

• Spend everything you've got - if you have little savings or earnings at retirement age, you'll do better with means-tested benefits such as pension credits.

• Put your savings into individual savings accounts (Isas). Income from these up to £3,600 a year is tax free.

• Be an amateur landlord - you need a tidy sum but there will be bargain properties over the next year or so. And you can leave this investment to your family - unlike pension funds.

• Check old pensions - plans from previous employers may be worth more than you think.

Some 95,000 retired public sector workers face reduced pensions after the government admitted yesterday it had uncovered evidence of a systemic overpayments that had gone unchecked since 1978.

The Cabinet Office minister, Liam Byrne, said the overpayments, valued at £126m, had been made for over 31 years across five schemes including the NHS, teachers, the armed forces, the judiciary and the civil service - 5% of the total number of people in such schemes.

Byrne's statement confirmed there would be no move to recoup the overpayments since ministers had been advised it was "unlikely to prove cost-effective".

The overpayment amounts are thought to average £1,300 per person in total. Pensioners will start to receive their corrected pensions in April 2009.

Affected pensioners had received notification by letter yesterday that their pensions would change. But the Royal British Legion, responsible for representing members of the armed services, said the letters were "non-specific" so people did not yet know what their pension payments would be.

The overpayment was first brought to light by the Lib Dems' Treasury spokesman, Vince Cable, in the Commons on Monday. Cable reported he had been in discussion with the cabinet secretary, Gus O'Donnell, about the overpayments made by the privatised company Xafinity.

They were "an error of the system" and not Xafinity's fault, said a government source yesterday.

In his statement, Byrne said there was "no single cause" of the problem and said the NAO would be investigating.

Responding to Byrne's announcement yesterday, Cable said: "These figures highlight decades of incompetence. Ministers apparently knew about this in March but completely failed to come clean."

Almost 95,000 former public sector workers will have their pensions cut, or increased by less than the value of inflation, as the result of a £126m Whitehall blunder, the government announced today. Around £1236m has been overpayed since 1978.

Why does the problem date back to 1978?

State pensions were given a substantial makeover that year. The idea was to add a second pension to the basic state pension, which had been around since 1948. This was a pension geared to an individual's earnings over a working life. The new pension was called Serps - the state earnings related pensions scheme. The problem arose with calculating benefits for those "contracted out" of Serps.

What does contracting out mean?

Employers pay an extra slice of National Insurance to fund Serps (now renamed state second pension or S2P). Occupational pension schemes can "contract out" - opt out of - Serps on behalf of their members (the employees). The idea is they invest the money to achieve a better return than would be provided by the Serps scheme. Occupational schemes that do contract out on behalf of their members must offer employees a benefit equivalent to Serps, known as the guaranteed minimum pension. Contracting out is to be abolished in 2012.

So why does the problem only affect those in public service?

The government discovered overpayments made to members of its own schemes. Others in non-government contracted out schemes may also have been overpaid - or underpaid - but no one has admitted this. Those who have been potentially overpaid - including teachers, NHS workers, the civil service and military personnel - are all in central government schemes. It does not involve local government workers as councils operate separate schemes.

What exactly went wrong?

Nobody knows exactly (or is not telling), but it seems there were errors in the annual updating or indexation of the pension benefits. These are revalued each year in line with rising prices.

Who is involved?

About one in 20 of those in the government schemes who have retired since 1978 - a total of 95,000 people.

How much was overpaid?

Around £126m over the past 30 years. This works out at an average of £1,300 a pensioner or £3.70 a month over that period, but exact amounts will vary depending on when an individual retired and how much they were earning over the years. Higher earners such as judges and top civil servants could have been overpaid much more than clerical workers or cleaners.

How much will my pension fall by?

Those affected will be contacted by letter over the next few days. It may take more time to calculate amounts as these will vary from person to person.

Will the government claw back the overpayments?

No. Recovery has been ruled out as "not cost-effective". In addition, many pensioners who may have been overpaid have died.

I have not got a letter yet. Does that mean I am not affected?

No. But most of those who were overpaid should hear by Christmas. If you are not contacted by then you can assume your pension is in the clear.

Does the problem affect people retiring in every year since 1978?

No one knows because the scheme adminstrators, HM Revenue & Customs and the Department for Work and Pensions are still investigating why the problem arose. But it seems likely that the 95,000 are spread across retirement years and salary levels.

I am receiving a widow's pension. Will my pension be cut?

As widow and widower's pensions are based on the entitlement of the late spouse, those involved will face a lower retirement income.

Have you had a letter detailing your pension overpayments? If so contact money@guardian.co.uk.

Employment

Many workers throughout Britain have lived free of the spectre of unemployment for more than a decade, but as job losses ripple out from the City to include giants such as Woolworths, a large number of people may now be forced to search in some unlikely places for work.

The rapidly expanding financial services sector is now likely to shrink, forcing many workers to search abroad for work. Those without families might decide to take a break from their careers or accept offers of unpaid leave from employers forced to save cash by cutting back the hours staff work. The four- or three-day working week could become commonplace, and employees with less cash in their pockets may seek second part-time jobs to top of their pay. We could be about to enter an era of moonlighting.

More secure if less well-paid jobs in the public sector will be highly sought after, and some high-fliers who were once picked off by City banks or hedge funds may join the civil service instead. A steady salary with a generous pension and good holidays will seem like an attractive proposition compared with a lucrative career in the private sector that could be over before it begins.

Heather Stewart

Property

Those lazy, crazy days of easy money from property are now a distant memory. Once your home, if you were lucky enough to own one, was a giant cash machine; but now prices have fallen by around 15 per cent and many are predicting a further 10 per cent decline next year. That could completely change the way we perceive property, transforming our homes from assets that underpin our financial health to expensive liabilities that many would rather be without. Those who can sell might do so, and choose to rent elsewhere instead, particularly now that owning a home no longer feels like a licence to print money.

Owning a second property abroad is also likely to become a less attractive option, especially with the pound close to record lows against major currencies and most major economies in turmoil. A good investment today could be worthless tomorrow. Closer to home, the era of mixed-use communities, with homes to buy and to rent sitting cheek-by-jowl, could be over.

As for buy-to-let, forget it. Just before the crash, two thirds of new homes in London were sold to investors, many of whom have been burned so badly that it may be years before they return to the market.

Today 170,000 households are estimated to have been in arrears for more than three months and that figure is expected to rise with jobless numbers. And in the years after the crash even those first-time buyers who get a mortgage may choose to tread carefully, waiting until they are settled with a steady job before taking on loans that will seem more like a financial commitment and less like an easy way to make money.

Ruth Sunderland

Young Britons

Forget Generations X and Y, and say hello to Generation Recession. For the nation's twenty- and thirtysomethings, the last downturn was lost in a blur of 'Madchester' and hip hop.

These young men and women have been suckled on student loans, then weaned on to credit cards, but a deep recession will provide a rude awakening for their generation, empowered by credit.

As the years of plenty draw to a close, plans for a second gap year will be shelved, and expensive holidays may be sacrificed for the odd weekend in the country. For the first time in a long time, the younger generation may even learn to save surplus cash as they attempt to survive the downturn, cutting back on disposable income.

The implication for trendy restaurants, clubs and bars could be frightening.

Those approaching 40 see the world through different eyes, with their view punctured by leaving school or college at a time when there were already two million unemployed - a figure that eventually scaled three million and looks like it may yet do so again this time around.

Today they remain conservative in their outlook, as memories of the dole and unpleasant DHSS officials linger.

But as the sleeping beast of unemployment stirs, young Britons are being forced to address their casual relationship with money - learning to deal in hard cash, not plastic. And they may also find they now have only one bank to turn to - their parents.

Zoe Wood

The elderly

For people looking forward to retirement or those who are already claiming state pensions, the economic crisis is likely to mean that life will now be far less comfortable. Many company pension schemes, most of them invested in the stock market, have been falling in value as share prices have declined, and the main hedge against that - property - is now on a downward trajectory too.

The result for savers is that they may have to defer the day when they clock off for the final time, at least until the market improves and their pension recovers in value. But the bad news doesn't end there. The Bank of England's decision to slash interest rates in an effort to kickstart the economy may come as a relief for homeowners who are on variable-rate mortgages, but that is of little help to those who have already paid off their home loan and are relying on savings, which will now be attracting considerably less interest than they were just six months ago.

Some will have to make economies or become part of the trend for remaining in, or returning to, the workplace after retirement age in order to make some extra cash. But with unemployment rising rapidly, even that may not be a viable option for much longer.

James Robinson