Millions of us have more than one pension – especially since the introduction of automatic enrolment in 2012. And, for workers outside of the public sector, these pensions are likely to be a Defined Contribution (DC) or “pot of money” arrangement.
Under current rules, every time the worker changes jobs they will be enrolled into a new DC pension and could therefore end up with a large number of relatively small pension pots.
So, is it worth consolidating these? Financial experts LCP have released a new paper “Five reasons to consolidate your DC pensions – and five reasons to be careful”, which sets out the pros and cons of doing just that. As they are pains to point out: “The answer for each individual might be different depending on the mix of pensions which they hold and the features of each one. But in an environment where workers will undoubtedly be encouraged or incentivised to consolidate their pensions, we hope that this document will provide an important sense check.”
So, first the five potential benefits of consolidating your DC pots…
1) The potential to pay lower charges
Under automatic enrolment, annual management charges on default funds are capped at 0.75%. In many cases however, people will be paying less than this on pensions used for
automatic enrolment: a 2020 DWP survey found that the average charge in qualifying
schemes used for automatic enrolment was just 0.48%. This is likely to be substantially
lower than the charge which many workers may be paying on pensions which they took
out before the era of automatic enrolment.
2) Rationalising your overall investment strategy
Consolidating your pensions will allow you to have more say in how the “assets” are allocated between growth assets (such as stocks) and more stable assets, like bonds. This, in turn, will reflect aspects such as your individual attitude towards risk, your age, capacity for loss, and so on.
3) Not missing out on innovations in investment approaches
Approaches to investment by asset managers are likely to have changed hugely from the start of someone’s working life to the end. Assuming that innovations in investment enable new savers to get a better mix of risk and return than would have been possible in the past, leaving money in old funds (where investment strategies may rarely, if ever, be reviewed) with more traditional approaches could mean missing out.
4) Better value when buying an annuity
The advent of ‘Freedom and Choice’ in pensions in 2015 meant that many DC savers are
no longer expecting to use their DC pot to buy an annuity. But there are tentative signs
that the annuity market is beginning to pick up and annuity rates are now rising from
historically low levels. And for those who are thinking of using some or all of their
retirement savings to buy an annuity, either now or later in retirement, having all of their
pensions in one place can improve the deal they get.
5) Easier to manage & engage with your pensions
Pension providers report that it can be hard to engage with savers at the best of times and if they are being bombarded with communications about pensions which, individually at least, are not worth large amounts, there is a real risk that workers may disengage from all communications about pensions. Consolidating them reduces that traffic and makes it easier to keep in touch with what’s going on with your pension pot… perhaps realising sooner if they need to save more or taking a more active interest in how their money is invested and whether this best meets their needs.
Now for five reasons to be careful when consolidating DC Pensions
1) Loss of Guaranteed Annuity Rates
The world of modern automatic enrolment pensions is a highly standardised one. In contrast, the “legacy” world of individual pensions was much more diverse and complex
and historic products may have beneficial features which could be lost if moved into a
more standardised modern workplace arrangement. The most obvious example of this would the “Guaranteed Annuity Rate” (GAR) which was attached to some DC pensions in the past. The idea of a GAR is that when the saver comes to retire they are not subject to the uncertainty of the annuity market at the time they retire but instead can access whatever annuity rate was guaranteed when the product was solved.
2) Loss of small pot privileges
Because pensions are a highly tax-privileged form of saving, there are various HMRC
restrictions on how much can be saved with the benefit of tax relief and on what happens
when pensions are accessed. But, in a modest attempt to limit bureaucracy, there are also
certain exemptions from these rules and restrictions which apply only to relatively small
pension pots. Those who consolidate their pensions risk giving up these advantages.
The key ones are Lifetime Allowance (LTA) and Money Purchase Annual Allowance (MPAA). Although these considerations may be of relevance only to a minority of people, losing
them could be costly for some.
3) Loss of tax protections
As well as the special privileges associated with small pots, consolidation could also
jeopardise tax privileges which may be associated with older pension arrangements.
These include the ability to take more than 25% tax-free cash and the ability to take a pension before the current “Normal Minimum Pension Age”. The NMPA was originally set at 50, before being increased to 55 in 2010 and is due to rise again to 57 in 2028. When the NMPA was increased to 55 in 2010, some policies already in force which had an NMPA set at 50 were allowed to retain this age, but this advantage would be lost if the individual transferred out.
4) Potential exit charges
Some older pensions may apply exit charges if the money is transferred out before
retirement age and this needs to be factored in before considering whether or not to
consolidate. For those aged 55 or over the FCA has now introduced a cap of 1% on exit
charges for contract-based personal pensions but those under 55 may face much higher
charges.
5) Lack of diversification?
For those who are seeking to be actively involved in their pension and its investment
strategy, there is much to be said for rationalising all of their pensions into a single pot. But
for those who intend to leave the management of their money to their new single provider
there is a risk in trusting all of their pension savings to a single investment approach. The
lay person may have little idea how to choose between different providers and may find it
difficult to judge who will do a better job of managing their money.
Given that there is likely to be variation in how well different providers manage your money, there may be a case for spreading your total pension wealth across more than one provider, perhaps with a view to rebalancing towards the one that does a better job with your funds.
There may also be some issues to think about with regard to transferring all of your
pension wealth to a single institution. For example, savers need to understand where they
would stand if their provider were to go out of business. Whereas the Financial Services
Compensation Scheme (FSCS) provides 100% cover when a pension provider goes out of
business, there is a cap on compensation of £85,000 for those investing in a self-invested
personal pension. This provides a clear reason for being wary of investing more than this
amount with a single SIPP provider.
In addition, there have been many high-profile examples where individuals have chosen to
put their life savings in a single investment where things have gone wrong. In some cases
these have been outright scams, but more broadly cases where money has been poorly
invested. Clearly, consolidating DC pensions need not imply moving all of your life savings
into a single investment vehicle, but there is a risk that some people may be taken in by
attractive advertising and may end up consolidating their savings in a way which is the
opposite of diversified and which puts their savings at considerable risk.
A further linked point is the behavioural ‘risk’ associated with having all your pension
savings in a single pot: if all pension savings are in single pot and markets are seen to fall (as with the start of ‘lockdown’ or following the Russian invasion of Ukraine), there is a risk that the inexperienced investor will overreact and perhaps sell out when the market is at its lowest. This is, of course, much easier to do – and therefore a greater risk – if someone’s entire pension savings are in one place.
You can read the full report on the LCP website:
