The power of consolidation

The Centre for Policy Studies, a think tank, recently suggested in a report that pension pots worth £2,000 or less should not face any fees or charges. They argued that this, coupled with the planned pension dashboard which the UK government has pledged will be introduced by 2019, will help encourage providers to promote consolidation of small pension pots.

Why consolidate?
This seems like a good idea to me - a similar threshold is already used in Australia. But why this need to consolidate? The nature of today’s transient working environment, means that people are forecast to have 11 different jobs during their lives, according to the ABI. Thanks to the success of auto-enrolment, with each new employer, employees are highly likely to be enrolled into a new company pension scheme, with the potential of amassing a number of different retirement savings pots through-out their career.

Although you could argue that having lots of pension pots is better than having none at all, there are a number of reasons why consolidation of small pots is generally a good idea. Holding a number of small pots can mean being charged higher fees as older schemes often levy higher charges than newer ones. Rolling different pensions schemes into one large pot, could result in large savings on charges.

Having multiple small pots can also limit the choices at retirement, making it more difficult to buy an annuity or arrange income drawdown. And it’s also easier to manage one larger fund than lots of smaller ones in terms of deciding the investment approach, so you could end up with better returns and more income in retirement.

Having just one scheme is much easier for individuals to keep track of - and for providers to keep track of members - so there’s less opportunity for it to be forgotten. The Department of Work and Pensions (DWP) estimates there is approximately £5bn lying unclaimed in private or workplace pensions and additional state pensions. As well as being harder, and more costly, for individuals to manage multiple pots, it is also a huge administrative burden for providers.

A growing problem
The problem is only going to get worse as, according to DWP estimates by 2050, there will be 4.7m small pots worth less than £2,000 in the UK system. Yet consolidating UK schemes is not currently very easy. The time and complexity involved in pension transfers, not to mention the potential fees, tends to be off-putting for individuals who are often already not interested in their pensions savings and therefore unlikely to see the need to take action when the amounts are quite small.

Clearly there is an argument for making the process easier and using technology to streamline procedures. The UK government pledge to create a ‘pensions dashboard’ by 2019 will allow savers to view all their lifetime pensions in one place. The scope of the dashboard is yet to be agreed, although the ABI has announced it is working with the government and industry to develop a prototype.

The Australian experience
In Australia, where auto-enrolment, known as superannuation, has been compulsory for 25 years, the government has been struggling to find a solution to the issue of multiple small pots. It estimates that around AUS$20.2 billion (£11.7bn) is languishing in lost pension accounts across the country. To deal with the issue, the government, legislated to create a single source of pensions data, like the proposed UK pensions dashboard, linking superannuation contributions to Tax File Numbers via the Australian Tax Office. Individuals can log onto the Tax Office portal and see the value of their active accounts as well as any old accounts.

Following on from the creation of the portal, the Australian government had intended to introduce an auto-consolidation system, where old pots would be transferred to the individual’s last active account. However, the plan has run into problems over whether some individuals will lose out on insurance cover bolted on to the pension, as the inactive account cover may be better than on the active account so plans to launch auto-consolidation for account balances of under A$1,000 in 2014, moving up to A$10,000 in 2016 have not yet gone ahead, although individuals can use the system to trigger the consolidation process manually.

And this will be at the heart of the problem of consolidation in the UK too. Although there are considerable benefits to consolidating pension pots, rather than simply lump pots together blindly, there is a need to ensure that important benefits offered by an old scheme are not lost in the process.

Control through technology
Technology can help here too though. For a dashboard to truly be useful, the system needs to not only give an overview of pensions savings, it also needs to include tools that help individuals make meaningful decisions about that money. This could mean interactive planning tools that allow users to understand how long their pension funds will last when taking different levels of income and whether they are on track to meet certain financial goals. It could give an illustration in actual money of how much consolidating pots would save in fees. Crucially it should also compare the benefits of different schemes held to help individuals, and their advisers, make informed decisions about how to manage overall retirement savings.

By offering these tools first, the ability to consolidate small pots electronically, and without fees, seems a natural, and next step for pension providers.