The state pension age will rise from 65 in 2024 to 68 by 2050, with payments linked to earnings instead of prices, which rise more slowly. The move will restore the link abolished by the Thatcher Government 25 years ago.
The deal is a compromise between Tony Blair and Gordon Brown after a battle between them over whether to implement a blueprint on pensions last November by a commission chaired by Lord Turner of Ecchinswell. He recommended that more generous annual increases in the state pension should start in 2010 but Mr Brown was worried that the cost could force a rise in taxes. He has delayed the start date until 2012 to give the Government more time to find the necessary savings.
Whitehall insiders said the 2012 compromise was proposed by John Hutton, the Work and Pensions Secretary, who will unveil a White Paper on pensions on Monday week. It will include a boost for women who act as carers or give up work after having children. Women are expected to qualify for a full state pension after 30 years' work instead of 39 as at present.
Legislation will be included in the Queen's Speech in November, allowing Mr Blair to hail a long-term solution to the pensions crisis as part of his legacy when he stands down.
But the Pensions Bill is unlikely to include a firm date for restoring the earnings link, fuelling speculation that Mr Brown might delay implementation beyond 2012.
The agreement states the deal is "subject to the affordability and the fiscal position" at the time, which could provide a get-out clause for the Chancellor.
Mr Brown told the Scottish Pensioners Forum in Edinburgh yesterday that the plan was "pro-pensioner but also pro-prudence." A senior Government source said: "This is a good deal for Tony. The important thing is that the earnings link will be restored and it will happen as early as 2012, subject to the affordability and the fiscal position at the time."
Lord Turner is said to be happy with the deal, which will curb the planned growth in Mr Brown's means-tested Pension Credit scheme. This has reduced pensioner poverty but would eventually be paid to seven in 10 old people if not reformed.
But Frank Field, Labour's former welfare reform minister, said: "This is a settlement to get the Government through the next seven days without imploding. It is not the basis on which you can build long-term pension reform, which has to last not for seven days but more than seven decades."
Pensioners' groups urged the Government to avoid "short-term political expediency" and take immediate steps to address pensioner poverty. The GMB trade union said the deal was "ludicrous and unacceptable".
Philip Hammond, the Tories' pension spokesman, said Mr Brown had lost his battle with Mr Blair, which would come as a huge relief to many people. "This is an important first step to securing dignity in retirement for pensioners," he said.