Background
The Government ran a consultation last year aimed at addressing the problem of “small pots” – small pension accounts that relate to former scheme members. This issue is expected to become more widespread as the auto-enrolment of millions of new pension savers begins later this year and as people tend to move job more frequently, which may lead to them having a larger number of pension scheme memberships during their career.
The reason why “small pots” pose a problem is that they are usually too small to allow the member to buy an annuity at retirement, so threatening his income in retirement, and they are not cost-effective for former employers and/or pension providers to maintain. The consultation tentatively defined a small pot as one with less than £2,000 in it. On this basis it suggested that there are already over a million “small pots” and this number is expected to increase by a further 4.7 million by 2050.
Having said that, as part of the same consultation, the Government set out its intention to abolish the right to pay a refund of contributions to scheme members who leave a scheme within two years of joining. The rationale for this was to ensure that those who are auto-enrolled stand more chance of building up a meaningful pension entitlement, rather than receiving a series of refunds if they move job frequently. The corollary is, of course, that this will add to the number of small pots!
The Government’s consultation put forward several options for dealing with small pots:
- tweaking the existing transfer regime to make it easier for individuals to transfer their pension,
- one or more “aggregator” schemes into which an employer or provider could transfer the pension pots of former employees automatically or
- a system whereby an employer or provider could transfer the pension pots of former employees automatically to their new employer’s pension scheme.
The Government’s response
Most respondents to the consultation agreed that tweaking the current transfer regime would not be enough to achieve consolidation of small pots, although many did acknowledge that improvements would be helpful. The pensions industry has now created a working group to explore the scope for such improvements.
In relation to the two specific automatic transfer approaches described in the consultation document, around 21% of respondents expressed a preference for transfers to the new employer’s scheme, while 61% supported an aggregator model.
Meanwhile, the Association of British Insurers carried out research amongst individuals to find out how they would like their pension pots to be treated. In this research 58% of individuals wanted their pot to move with them as they move employment, while just 10% wanted their pot to move to an aggregator scheme.
Although respondents to the consultation favoured the aggregator model, they did acknowledge that this might not lead to real consolidation. The Government’s Impact Assessment concluded that, with an aggregator, a limit of perhaps £2,000 on pots being transferred would be required, in order to avoid market distortion. This would leave many individuals with a number of dormant pots.
The Government projected that cost savings under the aggregator model would probably not materialise for about 15 years, compared with only 6 or 7 years for the “pot follows member” approach.
In conclusion, therefore, the Government has decided to proceed with the option of members’ pension pots following them automatically as they move jobs.
Not an ideal solution …
Where there is a large gap between employments, pots would remain dormant in the old scheme until the individual is automatically enrolled with a new employer. This clearly will leave a lot of small pots unaddressed, at least for periods of time. However, no alternative solution was offered to the pot remaining in the ex-employer’s scheme until such time as the member re-entered the job market or made some alternative transfer arrangement.
Other scenarios that would reduce the effectiveness of the automatic process – and so may need more consideration – are where an individual:
- becomes self-employed,
- earns an income below the qualifying earnings threshold for automatic enrolment,
- chooses to opt out of automatic enrolment next time,
- moves to a job with an open defined benefit scheme or
- has more than one job at the same time.
The system will start with small pots that are created through automatic enrolment. The consultation did explore whether it would be appropriate to transfer existing small pots as well but concluded that there was a greater risk of members becoming worse off, for example if the transferring scheme offered favourable rates of conversion to a scheme pension at the point of retirement. Defined benefit entitlements will also not be transferred automatically and, in all cases, the Government considers that there should be a provision for the individual to opt out.
Short-service refunds
In relation to the abolition of short-service refunds many respondents expressed the opinion that there is a case for allowing refunds of pots that are so tiny that they would not be worth transferring. Many such pots might result from late opt-out under automatic enrolment for example. Therefore, the Government proposes to explore whether there is merit in allowing schemes to refund these “micro-pots” (which might be those under £200).
The Government intends to explore the potential of a virtual amalgamation tool, whereby individuals can see all of their pension benefits in one place. It considers that this might enable people to engage more readily with their pension provision.
In summary, the Government proposes to enact legislation to allow automatic transfers to take place, to abolish short-service refunds and to enable an alternative mechanism for refunding micro-pots.