Government to press ahead with plans to consolidate small pension pots

Automatic enrolment is one of the big public policy success stories of our time. But it’s not without its flaws. People start a pension when they join an employer, but when they switch employer, they often leave their old pension behind, neglected and unloved. This has created a plethora of small pension pots which are easily forgotten.

Confirmation that the government will press ahead with proposals to automatically combine the very smallest lost workplace pension pots, worth £1,000 or less, will help to address the issue. Although there is much more still to be done.

At the centre of these proposals is the ability to automatically consolidate individuals’ pensions without them having to give permission. But this doesn’t have to be a foregone conclusion. Pension savers can opt out if they want to and consolidate their pensions in a plan that they choose themselves, offering them the features they value.

Current policy plans

Torsten Bell, the pensions minister, has made it clear that this is the start of the pension consolidation journey, and that the government has other pension workstreams in place to consolidate pension plans – including the creation of pension ‘megafunds’ and the launch of Pensions Dashboards. On this basis, we should be asking if an automatic consolidator is really needed and, given these other plans, whether this is the best use of government and pension provider – and ultimately pension saver – money.

Instead, we need an overall strategy and a clearer view on the sequencing of government plans – how they fit together and what they mean for workplace pension savers. Bell has promised this; let’s hope he delivers it soon.

It’s important to note today’s announcements also only apply to pensions used for automatic enrolment, which, broadly speaking, means most private sector workplace pensions set up since 2013. That means those with older pension arrangements are outside the scope of the exercise and should still be thinking about whether they wish to take steps to consolidate their pension pots themselves.

Pensions Dashboards could also have a big role to play, allowing savers to see all their pensions in one place online, reuniting them with lost pension wealth. But the government still needs to set a date for the launch of the dashboard, and it remains to be seen whether the project will ever yield results.

For those who want to take control of the pension consolidation process themselves, pension providers offer services that can help. Many providers, including AJ Bell, already offer simple, straightforward pension finding tools to make it easy for people to track down and combine their pension accounts. Getting pension dashboards in place could take things a step further and supercharge retirement planning by allowing savers to view all their pensions – including DC, DB and state pensions – all in one place.

Should you consider combining your pensions?

Confirmation the government will press ahead with measures to combine small pots doesn’t mean people should forget about taking control of the process themselves.

These measures will only impact the very smallest pensions and will see pots automatically moved to a new provider. People with larger pensions, and those who want to choose their pension provider themselves, will still need to take control of the situation if they want to consolidate their pension pots.

There are plenty of reasons why combining your pensions with a single provider can be a good idea. Most obviously, a single retirement pot is much easier to track and manage than having various pensions with different providers. You could also benefit from lower costs and charges, increased income flexibility and more investment choice by switching provider.

Older pension schemes, for example, often charge more than modern pensions, while plenty of workplace schemes don’t offer a full range of retirement income options or restrict your investments to the firm’s in-house funds.

While a charge cap of 0.75% applies to the default investment option in auto-enrolment workplace pensions today, many pension policies, including older contracts or those set up outside auto-enrolment, may carry higher fees.

The impact of reducing your pension charges can be significant, particularly over the long term. Someone combining three pensions with charges of 1.5% to 0.75% could boost their pension pot by over £7,000 over 10 years or £20,000 over 20 years if they were to switch to a single, lower cost account (see table below).

Source: AJ Bell. Assumes three separate pensions of £25,000 charging 1.5%, 1% and 0.75% are combined into a single account charging 0.45%. Assumes annual investment growth of 5% before charges.

How to combine your pensions

If you do decide to consolidate with a single provider, assuming these are ‘defined contribution’ (DC) pensions – where you build up a pot of money which you can access from age 55 – the process should be relatively simple. Note that the minimum age you can access your pension is set to rise to 57 in 2028.

If you have a ‘defined benefit’ (DB) pension valued at £30,000 or more, you will need to take regulated financial advice before transferring. Where DC savers build up a pot of money, DB schemes provide an income for life from a set date, usually based on your salary and the number of years you have been a member of the scheme. Lots of providers will only accept a transfer from your DB scheme where the adviser has recommended you do this.

You’ll just need to choose a provider with whom you want to consolidate your pensions and get the details of the pension or pensions you want to transfer over. Once you’ve given the relevant details to your new provider, they should do all the legwork for you.

Before transferring any old pensions, you should check there aren’t any valuable benefits attached which you may lose or exit charges that will be applied. Your provider should be able to tell you if this is the case.

You will then need to choose where to invest your pension. When doing this, make sure you are comfortable with the risks you are taking, have a diversified selection of investments and, crucially, keep your costs as low as possible.

Many firms offer a choice of diversified funds designed to meet different risk appetites if you aren’t confident choosing your own investments.

The Pension Tracing Service is a useful tool to locate missing pensions, and some providers also may be able help. AJ Bell, for example, has a ‘Ready-made pension’ service and pension finding tool, which allows people to find pensions and combine them into a ready-made pension account with a single annual fee as low as 0.45%.