How do you solve a problem like small pension pots?

In his article for Pensions Expert on 4 March, ‘Look before you leap’, Gregg McClymont put the case against workers exercising personal choice of provider under auto-enrolment. To an extent, we agree. But matters cannot be left there.

Auto-enrolment is widely regarded as a ‘success’ because more working people now save for their old age. Those who stay with one employer or within a single profession encounter few problems.

But many, commonly lower-paid, workers change jobs repeatedly. The industry is swamped by rising numbers of small dormant pots, something McClymont does not mention.

In 2022, there were approximately 11m deferred pots, with 2.2m of these worth less than £1,000. According to the Pensions Policy Institute, by 2035 there will be 27m dormant pots in master trusts alone.

Managing multiple deferred pots raises administrative costs, corroding savings. Most scheme members are entirely unaware how this damages their pensions.

A single ‘pot for life’ is certainly a desirable objective, but how to get there from here?

Finding answers

The alternative to worker choice is employer choice. But does this serve employees’ best interests?

Prior to auto-enrolment, some larger employers already offered pensions to higher-paid staff. Adaptations of these, or supplementary schemes run by the same provider, offered the easy way to comply with the new legislation.

Those employers (often small), who were obliged to offer a pension for the first time, would prefer a provider to take on the paperwork and guarantee compliance, a more expensive option.

Providers must respect basic conditions with respect to charges. However, employers do not pay charges. Members do.

Nor are employers required to guarantee savers’ long-term interests. The claim that ‘pot follows member’ risks transferring a worker from a good pension to a worse one cuts both ways. It is a lottery.

How other countries manage

Giving employers the right to choose was said to reduce employer’s paperwork. However, in Germany, where there is a plethora of providers, savers under the Riester pension system make the choice and stick with it for life. German employers have not complained.

The Swedish obligatory funded component of the state pension operated with a plethora of providers – more than 700 when it first opened. Users had to select for themselves, and many forgot their initial choice after a few years, according to research from 2001. Today, most new entrants choose the state-run default fund.

The one advantage of the Swedish system is its use of a single collection point and a personal identification number. This makes tracking pensions that much easier.

In the UK, providers are not obliged to record members’ National Insurance numbers. Many do not do so. They merely take names and addresses. It is not their task to update these unless they are directly informed by the members themselves.

Back to Turner

The comprehensive review of UK pensions offered in the Pensions Commission, led by Lord Adair Turner, dismissed the idea of choice two decades ago. Turner proposed a single provider for all those auto-enrolled into what was then called a personal account. This would have eliminated problems of choice and minimised lost accounts.

After the 2010 election, the coalition government opened the auto-enrolment market to competition. Private, for-profit, providers joined in. The rest is history.

Since then, the auto-enrolment system has been plagued by principal-agent problems, with the principal being the saver and the agents, respectively, employers and their pension providers.

Employers prefer providers who take on their administrative obligations. Providers seek maximum returns for investors. Turner’s original vision is undermined.

Where there are multiple providers, savers face too many options – “the paradox of choice”. This might have been a problem in Sweden, it probably was in Germany. Why savers chose as they did is unclear – their decisions may have been based less on a good appraisal of what really counts than on fashion, familiarity, marketing campaigns, etc.

However, whatever decision is made, thereafter savers disengage. Savers have their day jobs to do. Most lack the financial competence and mathematical ability to make decisions in this area. They possess no insight into economic developments, market performance or, in many cases, their future careers.

Where to from here?

At present, policymakers appear to want members to consolidate their savings. However, the pensions dashboard, initiated in 2016, has yet to materialise. The Pensions Tracing Service remains a little known (and limited) agency. There are commercial alternatives – but then the user pays.

The often-cited Australian system embarked on auto-consolidation of dormant pension accounts when individuals submit their tax returns. Progress has been slow, delayed by incompatible IT systems and associated technical issues.

However, consolidation per se is not enough. Turner also proposed a permanent Pensions Commission to oversee performance, publish results and control the endless tick-tock of regulatory change.

The Finnish Pensions Research Centre offers a prime example: advising government, parliament and public on past performance and future prospects.

Turner’s permanent Pensions Commission is a step towards safeguarding pension provision. Both the Labour Party and the Trades Union Congress favour this. But its establishment should not be an opportunity to postpone action on dormant pots. At present, discussion of this issue is the prerogative of experts.

Following the Post Office Horizon scandal, the failures outlined by the Parliamentary and Health Service Ombudsman’s report on WASPI pensioners have dominated the news. The government hardly needs to be caught in another story of unfulfilled retirement promises.

Bernard Casey is a retired academic now at SOCial ECONomic RESearch, based in London and Frankfurt. Noel Whiteside is Emeritus Professor of Comparative Public Policy at the University of Warwick.