Small pots consultation: 'Pot for life' approach seen as long-term solution

In its paper Ending the proliferation of deferred small pots Laura Trott, minister for pensions, said the growth of deferred small pots had been a longstanding issue which presented huge challenges to the automatic enrolment pensions market.

Without intervention, it warned that deferred small pots would result in wasted administration costs of a third of a billion pounds per year by 2030 for pension schemes and would severely reducing the value for money the schemes can provide to their members.

In January the DWP put out a call for evidence seeking input from the pensions industry after narrowing down the small pots solution to two options.

The call followed work undertaken by the PLSA and ABI led, small pots co-ordination group. 

Authorised schemes

The paper sets out the DWP's proposed framework for a model which will enable a small number of authorised schemes to act as consolidators for deferred small pots.

In the longer-term though it sees the need for a: "simpler system of workplace pension saving such as a lifetime provider model with each saver stapled to a ‘pot for life’, which may go further to solving this for existing and future pots".

The Department for Work and Pensions' (DWP) call for evidence ran between 30 January 2023 and 27 March 2023 and focused on two large-scale automated consolidation solutions – a ‘default consolidator’ model and a ‘pot follows member’ model, although it did include other options.

The DWP received 52 responses to the call for evidence, 19 from trust and contract-based pensions schemes, 18 from pensions industry professionals, three from employer/employee representative groups, one consumer group, eight financial services providers and three pension law firms.

Pensions dashboard

Most respondents to the DWP's call for evidence noted the need for any solution to work with other changes to the pensions system, for example the introduction of pensions dashboards.

The DWP said: "Most [were] agreeing that dashboards will simplify the process for members interacting with their pensions and may prompt members to consolidate their deferred small pots and therefore help to reduce the number of small pots within the system.

"Some respondents argued that pensions dashboards should be fully operational before a small pot solution is implemented in order to gauge its impact on member interaction with their pensions.

"The majority of respondents thought that innovation within the market could reduce some of the growth of deferred small pots over time but relying on market innovation to reduce the number of deferred small pots is limited by regulation, with respondents pointing to scams regulations and existing pension protection regimes as areas that prevent schemes from innovating further."

Minimum and maximum amount

The DWP said was no clear agreement from respondents on what the appropriate maximum pot size for consolidation should be, with some respondents noting that the maximum pot limit suitable for automated consolidation may "vary depending on the overall consolidation solution chosen".

"Setting the maximum too high increases the risk of member detriment if their pots are consolidated to a poorer value scheme, while also increasing the potential risk of market distortion. However, a balance needs to be achieved: some respondents suggested that the limit needs to be set at a high enough value to ensure that enough unprofitable pots are eligible for consolidation to ensure that automated solutions are cost effective and able to deliver overall net benefits to members."

Automatic enrolment

The call for evidence covered roughly 20 million deferred pots worth less than £10,000, most of which were within automatically enrolled charge-capped default funds and represented an estimated £30bn in assets.

The majority of these pots are below £1,000 in value, though this only represents an estimated 14 per cent of total assets in this sample. The average value of a pot smaller than £1,000 is approximately £350.

From the responses received, the cost of administering a pot averages out at roughly £20 per year, typically ranging between £5 and £25. There was no consensus on whether active or deferred pots cost more to administer.

"Respondents noted that if a minimum pot size is to be introduced, further thought needs to be given to the message it sends to members when it comes to pension saving, given that it may diminish the value of small pension pots to members and act as a disincentive for saving."

Clearing house

The DWP also proposed that a central clearing house be created to act as a central point in directing a members’ deferred pot and that members had an active choice when deciding which consolidator to choose; it wanted to hear views on appropriate solutions where a member did not make a choice and where they had multiple pots with the same provider.

"There was broad agreement, across a range of sectors, including pension providers and consumer/employee representative bodies, in their responses, on the potential benefits and implications of the default consolidator approach described in the call for evidence."

Gail Izat, managing director for workplace at Standard Life, part of Phoenix Group said the government has chosen to proceed with the consolidation option, in which any small deferred pots will be transferred to a pre-determined consolidation destination.

"We have some reservations with this approach as it currently stands, as it could run the risk of distorting competition. However, we’re looking forward to analysing the proposal in detail and working with the government and industry peers to make it a success for members.

“Our first preference would have been for a ‘pot follows member’, whereby pensions under a certain size automatically transfer when people change jobs. It’s 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."

Jon Greer, head of retirement policy at Quilter, said: "The government are therefore understandably wanting to ensure the market is working best for savers in this regard and are laying the groundwork for a shake up to auto-enrolment and put savers at the heart of the policy."

 "If you have multiple small pots, you could be paying unnecessary administrative costs. On top of that, some providers may offset their losses by charging higher fees on larger pension pots, meaning you could be cross-subsidising the costs associated with managing smaller pots.

"Consolidating your small pots not only can save money but simplifies your retirement planning. It reduces the administrative burden of managing multiple pots and, more importantly, minimises the chance of lost pension pots. Its estimated that in 2022 the value of lost pots had reached £26.6bn, which could have been avoided."

Proposed solutions to deferred small pots 

• Pot follows member: Greer said: "This option means your pot moves with you from job to job. It's slower and requires more transfers, which might mean higher costs, but it keeps your pot linked to your current employment. Businesses may also be reticent to approve this as it could put additional administration burden on them."

• Single default consolidator: "This is where all small pots are transferred to a single entity. It could potentially lead to substantial cost initially, but it could provide benefits such as economies of scale and simpler administration in the long run."

• Multiple default consolidator: "This option involves dividing small pots amongst multiple consolidators. This might mean less administrative burden as many providers already hold a high concentration of small pots."