Thousands of pensions to be excluded from plan to combine small pots

Tens of thousands of small pots could miss out on automatic consolidation because they have valuable benefits attached to them

Thousands of pensions are set to be excluded from Government proposals to automatically combine millions of “small pots” under new plans by the Department for Work and Pensions (DWP).

Earlier this year, ministers announced plans as part of its Pension Schemes Bill to automatically consolidate small pension pots – pots worth £1,000 or less – into one of several large schemes.

The aim is to simplify pensions management and help prevent people from having a large number of small pots generating insignificant returns, and instead help them build up a more sizeable retirement fund.

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You automatically join a new pension scheme each time you start a new job, unless you opt out, through a process called automatic enrolment. This has led to workers often accumulating multiple pensions over their career.

There are now believed to be around 13 million forgotten pension pots worth £1,000 or less, according to the latest estimates.

Under the Government’s plans, small pots will be automatically consolidated into one of several big pension schemes managed by authorised workplace pension providers.

Ministers have previously said combining these pots should boost people’s pension savings by an average of £1,000.

However, tens of thousands of small pots could now not be included in the automatic consolidation process because they have valuable benefits attached to them.

Some older pension schemes have special guarantees attached, such as allowing people to access their money at 55, or promising them a guaranteed annuity rate. Most modern schemes do not have these kinds of benefits.

Should the pots be consolidated under the new scheme, there is a risk these benefits could be lost.

The DWP confirmed it is planning to use a power in the Pension Schemes Bill – which would give it flexibility to decide which pots are included in the automatic consolidation system – to create a carve-out to exclude pots with these benefits.

A spokesperson for the DWP told The i Paper: “Our Pensions Schemes Bill includes the power to determine which pots are in scope for consolidation, and it is our intention that pots with specific guarantees and benefits could be excluded from the scope of automatic consolidation.”

According to estimates from Pensions UK, 0.5 per cent – or roughly 69,000 – of small pots could have these specific benefits attached to them, meaning they will be exempt from the consolidation plans.

What do experts think?

Tom Selby, head of public policy at pension provider AJ Bell, said it was “essential” that the final legislation exempted these pensions so that people do not lose valuable benefits without realising.

“It’ll be absolutely essential that any auto-consolidator scheme has in-built protections so people don’t lose valuable guarantees,” he said.

“Without this, a decent chunk of people would inevitably find themselves worse off from a government-initiated transfer they never asked for.

“Providers receiving automatic transfers would presumably also be quite nervous at the possibility they would be on the hook if someone had lost something valuable through a transfer.

“It should be simple enough for the government to specify the types of policies that are excluded, so it will then be on firms to make sure they have systems in place to sift out those policies.”

However, other experts said they were not expecting these pots to be excluded and that doing so could overcomplicate the process.

Steve Webb, former pensions minister and partner at consultants LCP, said: “When people are considering combining their own pension pots, it is certainly good practice to look out for valuable extra features which might be lost on transfer.

“But, for the consolidation of the very smallest pots, it is hard to see that it is worth the extra complexity needed to exclude such pots from automatic consolidation.

“With typical pots being consolidated worth under £500, the loss of access at 55 or the inability to secure a better annuity rate on such a tiny pot seems of limited value.

“This feels like a case where a simple solution is the best, especially since any complexity will add to the cost of the whole process, all of which will have to be paid by pension savers in the end”.

One technical expert, who has been working on the legislation with the government for three years, said: “As the legislation currently stands, that carve-out doesn’t exist.

“What will need to be explored through consultation is whether offering that carve-out significantly undermines the overall solution.”

The DWP spokesperson said: “We’re reforming the pensions market to drive economic growth, ensure greater security in retirement and put more money in people’s pockets, and the [Pension Schemes] bill could add £29,000 to an average worker’s pension pot by making their savings work harder.”