Should you consolidate your small pension pots?

Over two million small deferred pension pots are created each year as workers shift from one job to another at increasing rates.

If you have had several jobs, the chances are you have a deferred pension pot - this is a pension you no longer actively contribute to but hope to draw from when you retire. Thanks to auto-enrolment, deferred pension pots are now fairly common but not necessarily right for consumers as they ultimately cost you money and limit growth.

Small pension pots can also easily be lost, meaning you could miss out on pension benefits when you retire. 

Most people take little action or are unaware of the costs associated with keeping a small pension pot and consolidating them could make good sense. 

In a number of government documents around defined contribution pensions, the Department for Work and Pensions (DWP) said is currently exploring two options to help consumers better manage small pension pots and the costs. The options it is considering include:

• An automatic system where every deferred pot goes off to a third-party consolidator.
• Or - ‘pot follows member’, where deferred pots go with the worker and are added to their new active pot, allowing you to build a bigger pot.

The DWP set up a small pension pots working group in September 2020, but is now under pressure to implement changes sooner.

Steve Webb, former pensions minister and partner at consulting firm LCP, slammed the government, saying “it needs to get off the fence and take action".

“It has been obvious since the start of automatic enrolment that small pots would be an issue which is why the 2014 Pensions Act provided for a pot-follows-member solution. “Unfortunately this was not seen through and, nearly a decade later, we are still at the stage of ‘calls for evidence’ followed by further consultation,” he argued.

Webb said the ‘pot follows member’ option was an attractive one, meaning that member pensions would be consolidated with their current provider, possibly on very favourable terms.  

Alice Guy, personal finance editor at investing firm interactive investor, added: “The challenge of managing multiple small pension pots is a potential headache for investors and often makes it harder for savers to make investment decisions and maximise their pension wealth – and control their costs. Anything that makes consolidation easier must be welcomed. But regulators need to tread carefully as they consider automatic pension consolidation options, to help ensure investors remain in the driving seat and can seek out the best value options. Automatic consolidation could be a barrier to people finding the best solution for their needs as it is a blunt instrument and doesn’t always offer the best outcome for pension savers.”

DWP is still only at the consulting stage so it may be some time before action is taken. But for any who has several small pension pots, there are things you can do to maximise your pension savings and keep costs low.

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'll lower your fees, gain wider investment choice and better value when buying an annuity.

However there are things to think about before you consolidate your pension, said Webb.

“There are some cases where consolidation may not be a good idea, including where old pensions have valuable features (for example,  guaranteed annuity rates) 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 products 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, then you should probably leave it where it is. Though these are not available to most of the workforce today, anyone with one will have guaranteed benefits and they are considered ‘gold dust.’

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 house and forget to update your details with past providers.

Around £26.6bn sits in ‘lost’ pensions that have been forgotten about as people switch jobs frequently. 

If you think you may have had a pension at a previous job but 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. Though, 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 first to see if you can find the details first.