Making bigger pots out of smaller pots – the way forward

Small pension pots in the UK are set to become a major obstacle for the pensions industry once auto-enrolment is introduced. If a solution to the small pots problem is not employed before the abolition of short-service refunds, it could negate any benefits brought by automatic enrolment.

The Australian pensions industry has highlighted the perils of not having a consolidation process in place for small pots. There are 28 million superannuation accounts in the country – nearly three for each of the working population – and 6.9 million of these accounts are inactive. Research has shown that the small pots problem is set to intensify in the UK because of the highly flexible labour market, where on average individuals will work for 11 employers during their  working life[1].

CEO of NOW: Pensions Morten Nilsson

The effect of high job churn and new pension savers joining the market as a consequence of auto-enrolment will create an overwhelming number of small pots. This in turn will put strain on pension schemes and lead to poor outcomes for members. For members paying annual charges on several pots it will reduce the overall size of their retirement income significantly, and they may be unable to achieve a decent annuity.

The DWP paper presented two models that could be introduced to combat the problem of small pots. NOW: Pensions believe that both of the models presented will not fully address the issue at hand and therefore are proposing a unique model that combines the benefits of the aggregator model, with a few aspects of the job-to-job model outlined in the DWP consultation.

The simplicity of this model and its ability to promote good retirement incomes will ensure higher participation in the industry, as members possess key decision making power but by default smaller pots are auto-consolidated, to help members efficiently track them down and annuitise their savings upon retirement.

The proposed model:

  • After 6 months non-contributing members in a pension scheme will become deferred – this triggers a process whereby the current provider contacts the member
  • Once defined as deferred, members will be informed that their pot will be transferred out of the scheme within a set time period unless they opt for an alternative or decided to remain in their current scheme
  • “The Pensions Clearing House” is an intermediary that sits between schemes and aggregators; it acts as a portal instructing the ceding scheme to allocate the pot to one of the 3 aggregators. The distribution will depend on whether the member already has a pot at any of the aggregators; if a member has none, the clearing house will distribute the pots on a prescribed basis allocating them equally between each of the schemes initially.
  • Aggregator schemes are motivated to provide a good service to members both because of competition and government monitoring and guidelines. If an aggregator fails to perform according to a set of predetermined KPIs over a given period of time, they will be removed as a certified aggregator.
  • Members at any point can transfer their pots out of the aggregator to consolidate with a new provider. In the future, members will be able to find their retirement savings via the clearing house.

[1] DWP –  Meeting future workplace pension challenges: improving transfers and dealing with small pension pots

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