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The proliferation of small pension pots could undermine the entire auto-enrolment system, a policy expert has said, and impair decision-making at retirement, but how straightforward are consolidation models?
The Pensions Policy Institute estimates that the number of such pots in master trusts alone could balloon from 8m to 27m by 2035, with the average master trust account holding around £1,000.
Small pots are a problem because they can be eroded by charges and members can more easily lose track of their pensions. They also make the system less efficient, with the risk that any extra costs are passed on to the members in the form of higher charges, something the Australian system has suffered from.
The government has recognised the issue; understandably it does not make people save so they then still fall on the state - because they can’t find their savings or savings have been eaten up by charges - and its working group has recommended that the industry must come up with a solution to the problem.
The Pensions and Lifetime Savings Association and the Association of British Insurers in March set up an industry co-ordination group to look at potential solutions, which it intends to report back on in the summer.
A solution to stem the growth of small pots as people move from job to job is vital for the success of auto-enrolment, said Alyshia Harrington-Clark, head of DC, lifetime savings and master trusts at the PLSA, warning that without a change, the UK could have 50m dormant pension pots by 2050.
“Small pots is one of biggest issues and risks to the success of auto-enrolment,” she said speaking at an event organised by the Pensions Management Institute on Tuesday, adding that the time is now “to look at this issue and look at proliferation, because it risks undermining the whole system”.
This is not only because providers might increase their charges in order to cover the cost of administering a large number of accounts, but also because consumer behaviour could be influenced by the size of individual pots at retirement.
Source: PLSA
Having multiple pots is impairing decision-making at decumulation, said Harrington-Clark. “Small pots can be a really big problem at decumulation. Those with small pots tend to cash them in rather than use them as sustainable income,” she noted, and although this is not illogical, she said “it is something worth bearing in mind when we have freedom and choice”.
What are the options?
Consolidation does however not come free, and one of the biggest questions will be who will bear the costs.
Harrington-Clark mentioned pot-follows-member, a system already considered in 2014 and then abandoned. She said while this model has the advantage of harnessing inertia, “the costs were deemed to be very, very onerous”.
Another option would be for each saver to have a default consolidation scheme which holds their deferred pots. This also works with saver inertia and puts the burden on employers instead, who would be required to identify where an employee is auto-enrolled. “Quite lot of legislative and regulatory change would be needed,” for this solution to become reality, noted Harrington-Clark.
The co-ordination group will among others look at consumer preferences on what should happen with their pots, whether data standards are needed, and if the current transfer process can be made easier.
Could dashboards be obsolete at launch?
The government’s project to improve people’s engagement with long-term savings – the pensions dashboards – will not allow consolidation, offering basic ‘find’ and ‘view’ functions when they become available in a few years’ time. The DWP’s own working group acknowledged the limitations of dashboards when it tasked the industry with finding a better solution.
In the meantime, fintech startups are jumping into the gap. Companies like PensionBee offer consolidation, while new app Gretel promises to find not just lost pensions but most types of lost financial products from child trust funds to life insurance.
One of Gretel’s co-founders is the chief operating officer of its parent firm IntelliTeq, Tom Simmonds, who argued that the issue with dashboards is not just that they require engagement, but that data degrades over time, meaning it might have difficulty overcoming legacy data gaps and longer-term dormancy.
“What's the larger approach? Being able to engage with multiple assets – banks, insurer, pensions – under one technology umbrella. It's a utopia, but it’s efficient," he said.
How should small pot consolidation work? Who should pay for it?
