DWP is looking to address the growth of deferred small pots in the auto enrolment workplace pensions market. The call for evidence is to support the development of policy options for automated consolidation solutions. It ends on 27 March 2023.
It is part of a raft of policies announcement by the Minister for Pensions to create fairer, more predictable, and better-run pensions and help close the gap in the quality of provision between DB and DC schemes.
The call for evidence focusses on two large scale automated consolidation solutions – a default consolidator and “pot follows member”.
The Minister comments in the foreword that she wishes to develop an approach which puts the interests of members first by facilitating easy consolidation of deferred pensions, bearing in mind that whichever approach is taken needs to work for the whole of the automatic enrolment market.
Small pots have been a concern within the industry for some time. The 2014 Pensions Act set out a “pot follows member” solution – but it never came to fruition.
Research undertaken in the last few years has shown that member-initiated consolidation is unlikely, on its own, to stem the growth in small pots (although should be encouraged).
The purpose of the call for evidence is to deepen the evidence base around the scale and characteristics of the growth in the number of deferred small pots. It will build on the work already undertaken over the last couple of years by the Small Pots Working Group and the Small Pots Cross-Industry Co-ordination Group. The DWP state that the responses will help it develop its policy which it will then consult on in due course.
The approach to the small pots solution will also consider other policy developments and initiatives such as Dashboards, Value for Money and Stronger Nudge. It will also need to decide how to deal with protected pension ages following the change to normal minimum pension age in 2028.
Problems with small pots
The call for evidence sets out the problems small pots can cause (when there are a lot of them) for both providers and members.
Small pots are not profitable for providers and incur wasted administration costs and so impact on business models and potentially the financial sustainability of providers.
From a member perspective they impact negatively on value for money outcomes and make it harder for members to engage with their pension savings:
Small pots cause inefficiencies in the pensions market and those inefficiencies are passed on to the member. Small pots can be eroded through charges (even with the protections currently in place) and members with large pots can also be impacted as they may, in effect, be charged more to subsidise the lack of profitability of small pots.
Members may lose track of multiple small pots, they add an additional layer of complexity and members can struggle to engage with something they do not see as contributing to their retirement income.
The problem with small pots is a growing one and any solution should ideally address not just the existing stock of small pots but also the continued flow of new small pots.
The call for evidence highlights several issues:
Five Key assessment criteria
Solutions will be assessed against five key criteria:
- Priority will be given to delivery of overall net benefits for members through improved value for money outcomes, achieving a meaningful impact on the number of existing, and flow of new, deferred pots;
- Other criteria include that the solution complements member engagement, supports a competitive and efficient workplace pensions market, minimises the administration burden for employers, minimises complexity and commands confidence in the system – for both savers and tax-payers.
Member engagement and member-initiated consolidation
There are a lot of initiatives ongoing to try and help increase member engagement – simpler annual benefit statements, the launch of a pensions engagement season and pensions dashboards. Dashboards especially may help people engage with lost pension pots – including small pots. However, dashboards are unlikely to solve the problem of small pots on their own.
The call for evidence asks how member-initiated consolidation can be increased and also asks what the risks and limitations of this approach are likely to be. It recognises that there are barriers which prevent members taking action both around lack of understanding, difficulties with processing and nervousness around scams and that there will need to be member trust in any consolidation solution.
How small is small?
One of the questions asked in the call for evidence is how small should a small pot be? What is the maximum value below which a deferred pot should be considered eligible for automatic consolidation?
If the value is set too low it will not address the inefficiencies and costs providers are grappling with and the costs of implementing the solution could outweigh the savings from transferring out unprofitable pots. If too high members could suffer as a result of pots being moved into schemes with more expensive charging structures or lower investment returns. The call for evidence asks for comments on an appropriate starting limit – putting forward a figure somewhere in the £1,000 to £10,000 bracket as a possibility.
Micro-pots are also discussed. Should be a maximum pot size that is eligible for automatic consolidation, with micro-pots instead being eligible for refunds. The conclusion reached in the call for evidence is no, micro-pots should not be excluded from automatic consolidation as to do so (and allow refunds) would have a disproportionate negative impact on the pension wealth of lower earning individuals who change jobs frequently, undermine the message around the importance of long-term, sustained saving into a workplace pension and place a burden on providers to trace members to provide refunds.
When is a pot “deferred”?
As well as the question of pot size the other issue that goes to eligibility for automatic consolidation is when a pot would be considered “deferred”? The preferred solution is to set a prescribed period within which no member or employer contributions have been made. Other solutions were viewed as causing too many potential complications to what needs to be a simple system.
The call for evidence asks what a suitable period might be, acknowledging that certain factors will need to be taken into consideration, such as career breaks, decisions to stop contributing for a time and fluctuations of earnings.
Models for consolidation
The call for evidence considers two models for automatic consolidation; a default consolidator and “pot follows member”.
Under this model small pots would transfer automatically to the consolidator with members being given an opportunity to opt-out. There are several options as to how a member could be allocated to a consolidator and the call for evidence asks for feedback on these. One drawback to this method is the impact it would have on providers who are not designated as consolidators – they could be seen as less competitive and lose market share.
As well as a multiple default consolidator model the call for evidence also considers the option of a single default consolidator. This would have the benefit of simplicity and avoid the burden that would be placed on providers in a multiple consolidator approach in identifying if a member already has a consolidator pot or if they want to choose their consolidator.
Pot Follows Member
Under this model a member’s deferred pension pot would automatically move with them to their new employer’s scheme when they moved jobs (if it meets the criteria for automatic consolidation). This solution builds on the existing system rather than requiring new entities. However complications are envisaged in relation to multiple job holders and members who move jobs frequently. There is also a risk of increased burden on the active employer as the employee may ask more pension related questions. The maximum pot value limit set is also relevant here as members may end up reaching that limit quite quickly and the pot would then become “stuck” – so the member would still accumulate deferred pots, although less of them and at higher value.
The industry has been struggling with the issues around small pots for quite some time. The call for evidence is step in the direction of establishing a solution to that problem but it could still be some time before we see that solution in place as whatever policy the DWP develops following the call for evidence it will then want to consult on.
Both consolidation models that the call for evidence puts forward would have the benefit of removing small pots from current workplace schemes and that should ease the financial strain on providers therefore enabling a more efficient pension system. A more efficient pension system should enable providers to provide greater value for money to their members. Both solutions are also conceptually simple approaches, requiring minimal input from members, and should enable members to see more clearly what their pensions wealth is which in turn may enable more member engagement.