More than 5,000 retired firefighters will be compensated following a test case involving pension errors by the Government Actuarys Department (GAD).
The Pensions Ombudsman, an independent organisation that investigates complaints about pension administration, said GAD failed to review commutation factors within the firefighters' pension scheme.
Commutation is a procedure where a member of a pension scheme gives up part or all of their pension in exchange for a lump sum. Commutation factors set the rate at which the exchange is made.
The ombudsman said William Milne, the retired firefighter in the test case, was entitled to a pension of £29,610 and chose to commute the maximum amount of pension.
He received a commuted tax free lump sum of £111,038 and a pension of £22,207. When Milne retired in November 2005, the terms of the commutation had been in use since 1998.
According to GAD, at a review in 1998, it had recommended commutation factors should be reviewed in three years' time, but no review took place in 2001.
The ombudsman said the complaint should be upheld because GAD failed to review the commutation factors from 1998 to 2006 applicable to the calculation of the lump sum which Milne was entitled to receive.
In addition, the ombudsman said GAD had the responsibility to maintain and review the commutation factors and should have done so proactively.
The ombudsman ordered that a new commutation factor be prepared for Milne as if a factor review had been carried out in December 2004, and GAD should compensate the firefighter for the loss of money and any tax liability.
The Fire Brigades Union (FBU), which supported more than 5,000 of its retired members who were affected, said due to the number of complaints involved, the Pensions Ombudsman decided on a test case. Milne's case was chosen as a lead complaint.
Matt Wrack, FBU general secretary, said this was a "significant victory" for retired firefighters.
He added: "As the outcome has just been announced the FBU will be looking at the details and discussing the decision with its legal advisors."
GAD has prepared tables for use in the calculation, based on "a best reconstruction of the commutation factors which would have applied if factors had been reviewed and revised at 1 December 2001 and at 1 December 2004".
In addition, GAD said it had put in place internal controls to ensure its responsibility to review commutation factors in future.
A HM Treasury spokeswoman said the ruling would also have implications for police pensions. "The government accepts the Pensions Ombudsman's determination in full and will ensure that the directions made in relation to Mr Milne are taken forward in due course," she said.
"The government recognises that there may be other individuals who are potentially affected by the principles set out in this determination. Firefighters' and police pension schemes across the UK will work to identify such affected individuals and ensure that appropriate payments are made."