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The government is proposing to move forward with creating a framework of multiple default consolidators and a central clearing house to stem the proliferation of small deferred pension pots. Scheme members would need to choose a consolidator for their pensions or be allocated one. An industry group will be formed later this year to explore the design and implementation of the approach.
When auto-enrolment was introduced in 2012, this was done without a plan for dealing with deferred small pots. A proposal to introduce pot-follows-member was shelved in 2015, when the freedom and choice reforms were introduced. In 2023, there are already about 20m deferred pots worth less than £10,000 each across the entire defined contribution market, representing an estimated £30bn in assets, data responses to the Department for Work and Pensions’ January consultation suggest. Of these, 12.1m are pots worth less than £1,000, which amount to a combined £4.2bn.
Small pots are a headache for providers that charge a percentage fee, as the breakeven point is at around £1,000 for most providers, according to the data. For savers, there is a risk of forgetting about such pots or having them eroded by fees, particularly where a flat fee is charged. Those with larger pots on the other hand could increasingly be leant on to cross-subsidise the management of small pots as providers seek to move costs onto customers.
According to the Pensions Charges Survey, large master trusts charge an average of 0.4% in annual management charges, and some charge flat fees to help cover the costs of administration.
The DWP concluded that on average, this creates an average annual loss of between £3.60 and £18.60 per pot smaller than £1,000 for providers. Across the current 12m pots below £1,000, it means industry currently loses up to £225m per year – or moves the cost to large pots.
The government is now proposing to introduce a framework that would allow multiple master trusts to act as default consolidators, with authorisation from regulators. Defined contribution pots worth up to £1,000 would automatically be transferred to the chosen consolidator 12 months after the last contribution was made.
“In practice, master trust schemes will be required to apply to be default consolidators,” the DWP said. “Alongside this, we will work with the [Financial Conduct Authority] in the development of the regime to ensure alignment where needed, for example on whether contract-based providers could seek authorisation to act as a consolidator in relation to a contract-based scheme that they operate.”
Members would be given the option to choose their designated consolidator, as well as being able to opt out of consolidation. For dealing with those that do not make an active choice, the DWP offers two proposals - allocate all small pots between the providers who meet the criteria to be a consolidator at a level proportionate to their market share, or – given the likelihood that a member will have a deferred pot already with one or more consolidator schemes, the scheme holding the largest existing pot would become the member’s consolidator scheme.
Respondents to the January consultation criticised the consolidator model for the potential impact it could have on the market compared to pot-follows-member, but the government believes these fears are exaggerated.
“Our assessment is that given the existing concentration of small pots in large providers this is unlikely to be significant if the pot limit is relatively low at this stage, consistent with our aim of tackling a deferred small pots problem. If the limit was £1,000 and all £4bn in assets below this was consolidated into a single provider, this is only 4% of the master trust market,” it calculated.
Plan to set up a central clearing house
In its consultation, the Department for Work and PensionsDWP noted that a scheme seeking to transfer out a pot is currently not able to see where a scheme member has other deferred or active DC pots, posing a hurdle to the delivery of a multiple consolidator approach, therefore, “there will need to be a central point or system to store and manage the data”.
The DWP prefers a central clearing house – rather than a central registry, which would have been an alternative option. This A clearing house would not hold assets at any points but would communicate between the sending and receiving pension schemes. It could also contact members in cases where they have not chosen a consolidator. The consultation argues that this model would avoid any confusion that might arise under the registry, where someone could be contacted by different schemes at the same time, possibly choosing different consolidators.
However, the DWP acknowledges that the main downside of creating a central clearing house is cost, as well as “the potential for further complexity as a result of introducing a third party into the transfer process”.
Industry concerned about competition and complexity
Industry has welcomed the government’s focus on small pots but is sceptical about the consolidator approach, fearing market distortions.
Gail Izat, managing director for workplace at provider Standard Life, said the firm would have preferred pot-follows-member over the consolidator model:"We have some reservations [about] this approach as it currently stands, as it could run the risk of distorting competition.”
Izat argued that pot-follows-member would be “an easy concept for consumers to understand and, in a charge cap environment, concerns about the value for money offered by receiving schemes are lessened”.
Kate Smith, head of pensions at Aegon UK, said any solution to small pots should build on inertia, while the consolidator model requires some engagement from members choosing their default consolidator or opting out. However, she was also concerned that consolidators might not invest in member engagement around investment, becoming “holding pens” of member assets.
Smith also stressed member protection, saying: “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 automated consolidators under this process."
The Society of Pension Professionals welcomed the chancellor’s Mansion House speech and consultation responses, saying it supports the desire to address the issue of deferred small pots, as well as achieving value for money.
“We are pleased that the sentiment of our responses to these consultations are reflected, bringing together views across the industry with a shared desire to address these issues,” said Martin Willis, who chairs the Society’s DC committee.
The Investment Investing and Saving Alliance Exchange, TeX, which runs non-commercial contracts between fund managers, platforms and wealth managers, said addressing the small pots problem was a welcome move.
“To maximise the benefit of this consolidation policy, government action must be swift. As part of the solution, it is essential to ensure a fast and cost-efficient transfer process, allowing for consumers to reap the benefits of consolidated pots as quickly as possible,” said Carol Knight, director of TeX.
Tom Selby, head of retirement policy at investment platform AJ Bell, found the plans announced on Tuesday would not prevent the future proliferation of small pots or help people with deferred pension pots worth £1,000 or more.
“Ultimately, the government, regulators and industry need to focus now on enabling savers to more easily engage with their retirement savings and consolidate their pensions themselves. Pensions dashboards have the potential to make this significantly easier, but their introduction has been shunted beyond the general election. We now need more clarity from government on how and when dashboards will be introduced, so savers can see all their retirement pots in one place and consider combining them with a single, low-cost provider,” he argued.
What do you think about having multiple DC consolidators, with a central clearing house for communication?