Should you consolidate your small pension pots?

The government should automatically consolidate small pension pots to avoid them getting lost, according to a report by the Institute for Fiscal Studies (IFS).

There are a staggering 20 million small pension pots worth less than £10,000 that are not being contributed to, totalling almost £30 billion. Over half of these pension pots - 12.1 million - are worth less than £1,000.

The think tank warns that these figures have grown rapidly in recent years, and “the proliferation of these deferred small pension pots is burdensome for both savers and pension providers”.

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It is calling for policymakers to ensure that deferred small pots - “deferred” means you no longer actively contribute but hope to draw from it when you retire - are automatically consolidated together.

Many of these small deferred pension pots are created when workers shift from one job to another. They start saving into a new pension scheme, and no longer engage with the old pension from their former employer. The deferred pot is then at risk of being forgotten, especially if the saver moves house and doesn’t update the pension provider with their new address.

If you have had several jobs, chances are you have a deferred pension pot. Thanks to auto-enrolment, deferred pension pots are now fairly common.

If you forget about your pension, you won’t be aware of the fees or how it’s performing, and if you lose it completely, you’ll miss out on pension benefits when you retire.

Laurence O’Brien, a research economist at the IFS, comments: “Without policy action, many will end up with their savings scattered across several small pots by the time they reach retirement. This status quo is not fit for purpose: it is uneconomical for pension providers, leading to higher charges for savers, and it makes it harder for individuals to make good decisions on how to use their savings.”

We look at what the IFS is proposing, what the government is already doing to tackle the “small pots” problem, and what you need to think about if you’re wondering whether to consolidate your pensions.

IFS: “A strong case for deferred small pension pots to be consolidated by default”

The IFS argues that the number of small pension pots will only grow in future, as more people change jobs and are automatically enrolled into a new pension scheme every time, and that government action is urgently needed.

It highlights the “ridiculous” scenario of some savers having more than one pension pot with the same provider.

According to the IFS, there is a strong case for deferred small pension pots to be consolidated by default, with people being given the option to opt out of this consolidation if they wish.

This could be done by automatically moving all the money in someone’s deferred small pension pots into either the scheme run by their current employer, or into one of a number of default funds.

The IFS also says there are merits of going further than just consolidating small pots, and moving towards a system where people end up with one defined contribution pension pot, or only a very small number of these, as they approach retirement.

Lisa Picardo, chief business officer UK of PensionBee, says small pot consolidation, particularly for micro pots, can be “highly beneficial”.

She notes: “Our own research shows that nearly one in five UK adults feel certain or believe they have lost a pension pot, equating to approximately 8.8 million individuals. By making consolidation the default for micro pots, we can help savers take control of their retirement savings, reducing the likelihood of lost pensions while also improving investment outcomes.”

What is the government doing to tackle the “small pension pots” problem?

The Department for Work and Pensions (DWP) has been exploring how to help employees better manage small pension pots and their costs for the past few years.

It has been working on plans to automatically consolidate small pension pots of less than £1,000 into a third-party default consolidator scheme. The IFS suggests that this could also be done by combining a saver’s pots into one of their existing pension pots - but this has been ruled out by the DWP.

In October last year, the government repeated its commitment to developing pensions dashboards, which should make it easier for savers to view their pension pots, locate old ones, and combine pensions.

Rachel Vahey, head of public policy at the investment platform AJ Bell, says the government “needs to take a step back and survey the pensions landscape” as the plans all seem to be “separate endeavours, with no common thread binding them together or consideration of how one plan affects the others”.

She adds: “Pensions dashboards have a big role to play, allowing savers to see all their pensions in one place online, reuniting them with lost pension wealth. Targeted support [the FCA’s proposals to tackle the advice gap] can add even more value, providing more useful personal suggestions to those faced with solving the problem of multiple pots.

“But the government first needs to set in stone a date for the launch of commercial dashboards, offering a clear path forward for firms to deliver dashboards and allowing millions to view all their pensions in one place simply, easily and quickly.”

What to do if you have a small pension pot

If you have small pension pots from a previous job - around £10,000 or less - then it may make sense to consolidate them.

You could consolidate it into a current workplace pension, where costs could be lower.

Benefits to consolidating your pension include: your pension is easier to manage and track, you may lower your fees, gain wider investment choice and get better value when buying an annuity.

However there are things to think about before you consolidate your pension, according to Steve Webb, former pensions minister and partner at consulting firm LCP.

“There are some cases where consolidation may not be a good idea, including where old pensions have valuable features (for example, guaranteed annuity rates) that are not available with new pensions.

“There are also ‘small pots privileges’ which could be lost if you consolidate – for example, a pot under £10,000 can be cashed out without triggering the ‘money purchase annual allowance’, but a pot of £15,000 cannot. Consolidation should therefore be done carefully and thoughtfully and not as a knee-jerk response.”

Webb added that for anyone thinking about consolidation, they should shop around to get the best deal and make sure the pension scheme suits suit their needs.

“If the current workplace pension is not suitable or not available, do not just go with whoever has the best TV advertising campaign.”

Of course, if you have a defined benefit pension - which includes final salary plans - then you should probably leave it where it is. Though these are not available to most of the workforce today, they offer valuable, guaranteed benefits.

If you are unsure about what to do with a defined benefit pension fund, it is always a good idea to seek financial advice before taking any action.

How to track down your small pension pots

One of the biggest problems with having loads of small pots is that you are likely to lose track. This is often done when you move home and forget to update your details with past providers.

An estimated £31 billion sits in “lost” pensions. The average size of a lost retirement fund is £9,470, according to the Pensions Policy Institute.

If you think you may have had a pension at a previous job but are not sure where it is held, you can get in touch with your old employer and simply ask for the details. Then, contact the pension fund and ask for an updated statement and consider if it is worth consolidating.

If you are unable to trace your old pension, you can also use the government’s Pension Tracing Service via gov.uk. However, this isn’t a speedy option and it may take some time to track down old pensions, so it may be worth going through old paperwork to see if you can find the details yourself first.