At the last count, there were a whopping 18 million dormant pension pots1 – the vast majority low in value, with some holding as little as one pence.
Since 2012, whenever eligible workers start a new job, they are automatically enrolled into a pension scheme, and when they leave that job for the next one, the pension pot they’ve built up stays where it is. Rapid movement from job to job, low pension contributions and a large array of providers operating in the pension market are all reasons for this surge in small pots.
Put bluntly, auto-enrolment is a small pot creation machine – a side effect of an otherwise hugely successful policy that has set more than 10 million savers on the road towards a decent retirement.
The proliferation of small pots has negative consequences for savers as people risk losing touch with their pension pots, and hard-earned cash, as they move through the labour market. Costs for pension providers increase too – proportionately, small pots are more expensive to administer.
Based on Department of Work and Pension (DWP) figures, we anticipate £9.75 million2 is currently being raised via the General Levy and fraud compensation levy from dormant pots – a figure that is anticipated to increase. The General Levy on occupational and personal pension schemes recovers the funding provided by the DWP for The Pensions Regulator, The Pensions Ombudsman and the Money and Pensions Service and is levied against the number of members, regardless of how much they have in their pension pot.
It’s structured to ensure that every year it raises more money, meaning that with no policy change, we anticipate a 90% cumulative increase in our levy payment between 2018/19 and 2022/23; an increase of £1.6m. These factors help explain why 10 master trusts – including The People’s Pension – will pay a quarter of the total levy in 2020/21, even with no increase in the levy rate. They will pay 25% despite holding just 2% of occupational pensions sector assets, despite their members including millions of low earners in high turnover sectors who have small pension pots – many worth just a matter of pennies.
The growing problem of small pots is clear, the solution less so.
Sir Steve Webb, when Pensions Minister, proposed a system whereby pots would follow people from job to job. Pot follows member, as it was called, ran into difficulties for two reasons: first the high unit cost of a pension transfer – estimated at £100 split evenly between the ceding and receiving scheme. Secondly, the proposed system was impossible to secure against fraud by nefarious employers.
This provides us with plenty of learnings, meaning that any future solution to the small pots problem will need cheaper transfer costs as well as assurances around its security, will need to reduce the unit costs of transfer to a minimal amount and will need watertight security.
It will also need to ensure that any solution is automatic and removes the need for human intervention. We know this because in Australia, superannuation already has the functionality for people to voluntarily consolidate their ‘lost’ pension pots through the country’s pensions dashboard or have their trust-based provider do it for them. Australians don’t do this very much and we have no reason to suspect that Brits would be any more motivated.
Value for money matters too. Contract-based pension providers – where there is an individual agreement between members and providers – have been pushed hard by government and the regulators to get their act together following the bruising 2013 Office of Fair Trading report into the sector. Independent governance committees – bodies established by firms to oversee their contract pension scheme – are still too weak to fight the saver’s corner but they are a start. For master trusts, all eligible schemes operate inside a charge cap.
The regulation of retail pensions is much weaker. So any solution to small pots which risks opening the floodgates to a rush of pension savings from lower cost, better governed workplace pensions into more expensive retail pension products would have unintended consequences. Costs matter so much over the long term of a pension saving arrangement.
There are some factors limiting the growth of small pots. Some pension schemes operate a ‘single pot’ model. Both NEST and The People’s Pension ensure that people who are re-enrolled back into these schemes keep saving into their old pot, preventing the growth of small pots.
Then we have the consolidation of the market, with the master trust authorisation round of 2019 more than halving the number of master trust pension schemes and we expect consolidation in the single employer trust space to continue. The DWP could help handle the small pot problem by further forcing the pace of consolidation, following their consultation paper on the issue earlier this year.
What is clear is that soon the pensions sector will need to come together to hammer out a solution to the small pots issue and prevent the problem developing further.
1. Figures from the ONS Occupational Pensions Schemes Survey, UK 2018: https://www.ons.gov.uk/peoplepopulationandcommunity/personalandhouseholdfinances/pensionssavingsandinvestments/bulletins/occupationalpensionschemessurvey/2018
2. Estimate taken from Department for Work and Pensions data: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/191697/automatic-transfers-consolidating-pension-savings.pdf