Research released by the Pensions Policy Institute warns that the proliferation of small pension pots risks undermining auto-enrolment success, unless significant government intervention is undertaken.
The research, sponsored by Now Pensions, estimated that by 2035 there could be up to 37m deferred pots in master trusts, dwarfing the number of active pots and creating instability in the market.
There are already 10m small deferred pots, potentially rising to 27m in 15 years. The PPI report estimates that the cost to master trusts of managing active and deferred pots will hit £1bn by 2035, while member charges could rise to £1.2bn.
While at present each active member enrolled in an AE scheme is supporting one inactive member, should the rise in small deferred pots continue unchecked that balance could be skewed, with the result being that each active member will end up supporting three inactive members.
The proliferation of small pots is not good for members: they cannot benefit from economies of scale; easily lose track of their deferred pensions; and face multiple charges on each pot
Joanne Segars, Now Pensions trustee
“Member charges often erode small, deferred member pots over time, and small pots can be uneconomic for providers to manage,” said Mark Baker, senior policy researcher at the PPI.
“Much of the debate around deferred members to date has concentrated on charges. However, all charges erode small pots to some extent, meaning that there is a need for a more holistic and strategic policy change if the problem is to be addressed meaningfully,” he said.
The PPI considered a number of policy options for greater pot consolidation that reduce the number of deferred pots, the charges members must pay, and the costs to providers, he explained.
“However, the policies cannot be judged solely on their economic impact. All policies involve trade-offs and some present potential market difficulties such as giving some schemes a competitive advantage or encouraging cherry picking of members who appear most profitable.”
Given the extent of the proposed changes, a “strong consensus amongst providers and legislators” is required, he said.
“A combination of several approaches, supported by pensions dashboards, might help members and industry to achieve potential benefits, while avoiding some of the potential pitfalls involved in the different approaches.”
Providers call for action
In response to the findings, Now Pensions called for a small pots task force, made up of government, regulators, industry and consumer groups, to be formed by the end of the year, with proposed solutions to be delivered by the end of 2021.
Adrian Boulding, director of policy at Now Pensions, said: “The PPI work has revealed no single magic bullet will provide an immediate fix for the problem of small pots. There are merits and drawbacks to all the solutions on the table.
“Until the issue of small pots is resolved, the cost of small pots must be paid for in some form. We welcome the government’s recognition that a complete ban on flat fees could eliminate competition in the market and force up fees for savers. To pull the funding of small pots by changing the charging structure will destabilise the market,” he said.
Joanne Segars, chair of trustees for Now Pensions, added: “The proliferation of small pots is not good for members: they cannot benefit from economies of scale; easily lose track of their deferred pensions; and face multiple charges on each pot – for administration, benefit statements and levy charges, for example. This all eats away at their final pension pot.
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“The solution has to be to help members join up their pension pots. This needs careful and co-ordinated thought, and it is something we must now collectively tackle to ensure the best outcomes for members,” she said.
Now's call drew support from other providers. Smart Pension director of policy Darren Philp commented: "The small pots problem needs a solution and needs one quickly, and we support the creation of a taskforce that would drive this work forward. If we are to learn anything from Australia it is that the government and tax authorities only acted when the problem got too big to ignore. We need to avoid that mistake in the UK."
