Prospect and Bectu members are increasingly finding that they have many pension pots from different providers and are wondering whether it makes sense to try to combine them. Our Pensions Officer Neil Walsh takes a look at some of the factors that you’ll need to consider.
Broadly, we’ll consider the following areas in turn:
- Why there’s been an increase in the number of pension pots and finding ‘lost’ pots
- Reasons to consolidate your pension pots
- Reasons to be wary of consolidating your pensions
- How to combine your pension pots
Increase in number of pension pots due to automatic enrolment
This situation has been driven by the introduction of automatic enrolment between 2012 and 2019.
This required employers to make pension contributions on behalf of eligible employees and workers. Over 10 million people have since been automatically enrolled into pension schemes.
The impact has been mostly felt in the private sector, where many employers or engagers did not previously contribute to pension schemes on behalf of employees or workers.
In these areas, the most common type of pension scheme offered are called defined contribution pension schemes.
These schemes are essentially pots of money that members and employers pay into. Members may also benefit from tax relief and National Insurance savings (if salary exchange operates).
The pension pots are invested in a range of different assets that are offered by the pension provider, such as UK and international equities; government and corporate bonds etc.
These pension pots grow over time and, at retirement, the member can use the accumulated value across all their pots to secure income for the rest of their life.
It should be noted that each employer or engager picks the pension provider for the period of time that you work for them.
This restricts your ability to consolidate pension pots simply by choosing to have your contributions paid to an existing pot you had already set up.
Since automatic enrolment started, you only have to be a member of a defined contribution pension scheme for one month to keep the accumulated pension pot with a provider.
All the above factors have led to a situation where more and more Prospect and Bectu members have increasing numbers of pension pots, and now face questions about how to manage them.
How to find lost pension pots
In the extreme, it is very easy to completely lose track of a small pension pot that you had in relation to a short-term engagement (maybe one that was in addition to your usual work).
As the number of total pension pots begins to soar, the number that members lose track of will naturally grow too.
You can use the Pension Tracing Service to find any pension pots you may have forgotten about, or otherwise lost track of in the past.
Why it can be a good idea to consolidate your pension pots
A useful starting point to the question of what to do with different pension pots, is to acknowledge the good reasons there can be for combining them (but make sure you also read the warnings!)
Some of the main reasons are summarised here (and explained in more detail below – please note that not all the reasons carry the same weight).
Four reasons to consolidate your pension pots
- Potential to lower the charges that you pay
- Easier to plan for your retirement
- Improvements in technology and investment approaches
- Potential for better value when using pension pots to secure retirement income
1. Potential to lower the charges that you pay
The amount of charges that are deducted from your pension pot obviously has a direct impact on the value of funds that are then left for you to use to secure income in retirement.
It’s not generally possible to predict which provider will produce the best investment returns over time (indeed, it should be possible to replicate similar strategies / returns with different providers).
But one thing you can control is the amount of funds that providers deduct from your pension pot in the form of charges.
Providers’ charges can be expressed in a number of different ways (eg as a single percentage of the pot value, as a combination of a percentage of the pot value and a different percentage of each new contribution made or as a combination of a percentage of the pot value and a monthly or annual flat fee).
Small differences may not seem significant, but a reduction of even 0.1% in the percentage of the pot value could result in your pot being thousands of pounds higher when you retire.
There is a statutory cap on charges that apply to the default arrangement for pensions schemes used for automatic enrolment. The charge cap is 0.75% of the funds under management (equivalent caps apply for schemes that have a combined charging structure).
Large schemes used for automatic enrolment can often offer charges that are much lower than the cap. Many Prospect and Bectu members are in schemes with charges as low as 0.3%.
If you have legacy pension pots with relatively high charges (maybe because it was started before the charge cap was introduced or it was a personal arrangement which often have higher charges) then you can potentially benefit by consolidating these into a pot with lower charges.
Conversely, if you have a previous pension pot with very low charges but the scheme offered through your current employer is more expensive, then you are unlikely to benefit from transferring that pot into your current one.
Many Prospect and Bectu members, particularly those who work on a series of shorter-term contracts, will have come across NEST. NEST was established by the government as part of automatic enrolment; it has a legal obligation to let any employer or engager who needs to, offer it as a pension provider to their employees and workers. If you have a NEST account it is worth noting that currently the annual charges for any pension pot you transfer into it are 0.3%. This means there is a low-cost consolidation option available to many people.
2. Easier to plan for your retirement
The brutal reality is that the legal minimum level of pension provision required under automatic enrolment is unlikely to allow most people to retire at a reasonable age with a comfortable standard of living.
Thankfully, many Prospect and Bectu members have access to pension schemes that are much better than the statutory minimum, but this will not be the case for all.
Whatever the quality of pension provision offered to you, it is important to have at least a high-level plan for retirement (ie an idea of when you would like to retire and how much income you would need then to maintain a comfortable standard of living.)
It is also important to monitor how your pension savings are performing against this high-level retirement plan. If you have many different pension pots with lots of providers, then this process becomes much more difficult.
If unnecessary complexity delays, or even prevents, you from reviewing the level of your pension savings, this could impact when you get around to taking action to improve your retirement outcomes.
For this reason, greater consolidation can lead to easier retirement planning and better outcomes as a result.
Consolidation can also help you ensure that important administrative issues are up-to-date and consistent (eg that all the pots have the same target retirement age and the appropriated nominated beneficiary for any death benefits.)
It’s also easier to ensure you have a consistent overall investment strategy across your all your pension savings if you have consolidated your pension pots.
3. Improvements in technology and investment approaches
A pension product is a long-term investment, you might be a customer of a provider for many decades. There is a lot of innovation in the pension industry over time. It may be that some older pension pots do not have all of the features that newer providers can offer.
Consolidating your pots can help ensure that you do not miss out on new developments. These could take the form of new technology and interfaces that help you access and interpret information about your savings or investment options that were not previously available.
4. Can you get a cheaper pension?
We save into pension pots in order to provide an income throughout our retirement. Previously, the most common way to do that was to use the pension pot to buy a series of regular payments (ie a pension – called an annuity) from a pension company.
Buying an annuity is not as common now as it was. A big reason for this is that annuities became very expensive, people questioned their value. The government also relaxed the rules about what you could do with your pension pot, so many people were free not to buy an annuity any more.
But annuity prices have improved more recently, and many people feel the need to have a degree of certainty about the level of income they can rely on from a certain point of their retirement. So they are coming back into fashion of a sort.
If you are buying an annuity, you might find that providers offer incentives for larger transactions. One £100,000 pot might be offered a better rate than two £50,000 ones. For this reason, it can be worthwhile to consolidate your pension pots before you use them to secure income in retirement.
Reasons to be wary of consolidating your pension pots
The previous section covered the potential advantages from consolidating past pension pots with a single (or just fewer!) providers.
But there are certain features of pension pots that can be particularly advantageous. There is a risk that they could be lost if you transfer the funds to another pot.
It is important to check whether these features apply to any of your pots and whether they are worth retaining.
These features are summarised here (and explained in more detail below.)
Four features to look out for before transferring a pension pot
- Loss of guaranteed annuity rates
- Loss of the tax benefits associated with small pots
- Loss of the tax benefits associated with older pension pots
- Exit fees
1. Loss of guaranteed annuity rates
Annuities were described in the previous section. They are the regular pension income you can get throughout retirement in return for a lump sum paid to a provider.
In the past some pension pots came with a guaranteed annuity rate (GAR). This meant that the provider gave you fixed terms for the future pension income that your pension pot could buy.
Over the years, annuities have become a lot more expensive. More expensive than providers expected they would be.
This has made some of the rates previously guaranteed look very generous today compared to the rates available on the open market.
If you took the funds out of a pot that came with a GAR, you will lose the right to take advantage of that rate and could end up with a much worse outcome.
GARs were a legacy feature of older pension pots. It is definitely worth checking whether any pot had a GAR before transferring it to another and potentially losing it.
2. Loss of the tax benefits associated with small pots (under £10,000)
There are two potential tax benefits associated with small pension pots (ie under £10,000) that you could lose if you consolidated them into a bigger pot.
These benefits may not affect huge numbers of members, but they could be quite significant to those people that are impacted.
Money Purchase Annual Allowance
You can normally save up to £40,000 in your pension pots in a tax-year. This is usually enough to cover the vast majority of savers (even those in very generous workplace schemes.)
But after you first take cash out of a pension pot (beyond the 25% that is tax-free) you can be restricted to a lower limit of £4,000 (called the Money Purchase Annual Allowance.)
This lower amount might be less than what your employer will pay into your workplace scheme, so it can be quite restrictive and potentially prevent you from being able to access pension pots while still working (because of this restriction on how much you could save afterwards.)
However, you can cash in up to three personal pension pots (and an unlimited number of workplace pension pots) worth up to £10,000 without triggering the Money Purchase Annual Allowance.
Consequently, it could be advantageous to keep a small pension pot separate so that you can access it while still working without triggering this lower limit for future pension savings.
Lifetime Allowance
If you have a lot of pension savings, you might be impacted by the Lifetime Allowance (currently £1,073,100.) Savings in excess of this amount may be subjected to a charge.
You can cash in up to three personal pension pots (and an unlimited number of workplace pension pots) worth up to £10,000 without using up any of your Lifetime Allowance.
Consequently, your tax liability could potentially be lower if you keep a small pension pot apart from the rest of your savings and cash it in separately.
3. Loss of the tax benefits associated with older pension pots
Pension tax rules have changed over time. Sometimes beneficial features of previous regimes are retained by pension pots that were first opened under the old rules.
Again, there may not be lots of pension pots with these features, but it is worth checking before transferring any.
For example, pension pots that you started saving into before April 2006 might allow you to take more than the current standard limit of 25% of the pot as a tax-free cash lump sum.
If you have a pot with this feature, and you value that, then it might not make sense to transfer the funds into another pension pot which restricted the tax-free lump sum to a lower level.
Older pension pots may also have a protected normal minimum pension age that allows access to funds earlier than pots governed by current rules.
Again, if you have a pot with this feature and you value it, then that might offset any potential benefits from consolidating with other pots.
4. Exit fees
Most current pension pots will not have exit fees. Some older pots may do (or may have other penalties associated with early withdrawal of funds.)
It’s important to take any such charges or penalties into account in assessing whether to consolidate pension pots or not.
How to combine your pension pots
Once you have decided that you want to combine some (or all) of your pension pots, the process for doing this should not be too complicated.
The process will be smoother if all of the providers managing your different pots have your up-to-date personal details, so it is worth checking these.
The main decision will be which pot to move other pensions into. This decision will be based on many of the same factors set out above.
Once you have selected a pot to use to consolidate your pensions, you can tell them you wish to transfer other pots in.
Usually the provider you have chosen to hold your combined pension pots will contact the other providers and make the practical arrangements for this.
You will usually need to supply this provider with the details of the pots (eg policy number etc.) that you are looking to transfer over.