The Department for Work and Pensions (DWP) has set out plans to tackle the £27 billion “lost” pension pots problem that occurs when a worker starts a job at a new company and the pension becomes “deferred”.
Default “consolidator” schemes will be created to sweep up small deferred pension pots worth less than £1,000.
It means savers with workplace pensions that they are no longer contributing to will be transferred automatically to a consolidator (or consolidators), although they will be able to opt out of “auto-consolidation” if they prefer to stay with their existing pension provider.
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Thanks to auto-enrolment - where most employees are automatically placed into pension schemes - deferred pension pots are now very common, as workers frequently switch jobs and therefore open new pension schemes. Employees are likely to build up multiple pension pots as they change jobs during their careers.
But having lots of little pension pots creates an admin headache, as they potentially get forgotten. The value of pensions becoming disconnected from their owners has ballooned by over £7 billion, from £19.4 billion to £26.6 billion, between 2018 and 2022.
Some small pension pots have high fees and limited investment options. Combining them into one pension scheme can save money and boost growth.
The DWP has been investigating ways to solve the problem of “deferred small pension pots”. Pensions minister Laura Trott said a longer-term solution could be an Australian-style “pot for life” model. She said: "In the longer-term, a simpler system of workplace pension saving could emerge to deal with the issue that new pension pots are created each time someone starts a new job, for example, a lifetime provider model with each saver stapled to a ‘pot for life’.”
The government has made a series of other pension announcements this week, ranging from using workplace schemes to invest in unlisted equities to establishing a “value for money” framework.
We explain what’s been announced and how it could affect you.
Consolidating small pension pots
The DWP has been exploring how to help employees better manage their small pension pots. It proposes that “default consolidators” are created to collect up small deferred pension pots that are worth less than £1,000. This would be an automatic system where deferred pension pots go off to a third-party consolidator.
Following a consultation, the government said: "We have concluded that the multiple default consolidator model is the optimum approach to addressing the deferred small pots challenge and has the potential to provide greater net benefits to members, ensuring that members’ eligible deferred pots are consolidated into one scheme.”
The model aims to consolidate an estimated 14 million small pots that are collectively worth £4 billion.
It means that the previously considered "pot follows member" approach is now off the table.
The DWP is running a further consultation to work out what a consolidation framework would look like and how it would work for savers.
Tom Selby, head of retirement policy at the investment platform AJ Bell, said the surge in lost pots is “piling the pressure on the government to find a solution”. He added: “Part of the reason the government is focusing on small pots is that automatically transferring someone’s pension without getting their permission first comes with real risks. It is possible, for example, that someone might have their retirement pot moved to a scheme with higher charges or worse investment performance, or both. While it is logical to look at ways to increase scale and efficiency in the pension system, protecting the consumer must be the number one priority.”
According to Kate Smith, head of pensions at the insurer Aegon UK, many people with small pension pots are “low earners and are likely to be the least engaged with their pension savings”.
She commented: “This means any solution needs to be built around the auto-enrolment principles of inertia, or ‘going with the flow’ and focused on supporting those small pot savers’ needs.
“It’s fundamentally important that automated consolidators have the highest level of value for members, and that only authorised schemes are allowed to act as consolidators under this process. This will protect members from being automatically transferred into poor value high-cost schemes leading to poorer member outcomes.”
Value for money workplace pension schemes
The DWP has also been busy establishing a “value for money” framework for defined contribution (DC) pensions with a focus not just on costs but also potential investment returns.
A joint paper by the DWP, the Pensions Regulator and the FCA says the roll-out of the framework will be completed in phases, the first of which will be aimed at default workplace pension schemes. Future phases will extend to drawdown pensions, as well as personal pensions.
The metrics will cover a wide range of areas including past investment performance, charges, communications, and administration. The plan is to boil all that down to a single red, amber or green rating, which the DWP expects to be published by the industry in league tables.
Where there is continued underperformance, regulators will be given the necessary power to intervene, removing persistently poor-performing schemes.
The paper shows that over a five-year period there can be as much as a 46% difference between the highest and lowest-performing pension schemes.
However, Alice Guy, head of pensions and savings at Interactive Investor, said many savers would struggle to compare pension providers. “The value for money framework was supposed to make it easier to compare pension schemes, but having a separate disclosure on performance and fees will make it almost impossible for pension savers to compare performance between providers.”
She also said providers should be benchmarked against the wider pensions market, not just their peers, and that it was “a missed opportunity to tackle unfair pension fees once and for all”.
Investing in unlisted equities
There has been a lot of talk recently about using pension schemes to kickstart the UK economy. In other words, encouraging (or even mandating) pension funds to invest in fast-growing British start-ups and infrastructure, rather than focusing on gilts and listed equities.
The chancellor used his Mansion House Speech yesterday to announce an agreement between nine pension providers, committing them to allocating 5% of assets in default funds to unlisted equities, by 2030. A consultation on setting an ambition to double investments in private equity to 10% for Local Government Pension Schemes has also been launched.
Jeremy Hunt said: “For an average earner who starts saving at 18, these measures could increase the size of their pension pot by 12% over their career - that’s worth over £1,000 more a year in retirement.”
However, pension experts have pointed out that private equity is illiquid and high-risk and may not be suitable for people’s retirement savings. There is a risk that hard-working savers will be forgotten in the government’s efforts to boost the economy.
The government later clarified the 12% figure, saying the returns for savers with private equity investments within their pensions will be only “slightly higher” than without, “as the fees and charges associated with private equity are assumed to be greater than investment in equities and bonds, lowering the overall return. This is particularly the case when assuming a 2/20 fee structure (2% per annum charge with a further 20% performance fee for returns above 8%).”
According to the government, the greatest impact on pot sizes will actually come from the reforms already proposed of removing the lower earnings limit on workplace pensions and lowering the starting age for auto-enrolment from 22 to 18.
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