Small pension pots: problems and potential policy responses

Summary

The current system of private pension savings in the UK is based on employers choosing a workplace pension provider, to which contributions from the employee and employer are sent, and which invests the contributions on behalf of the employee. This means that when an individual leaves their employer (or otherwise ceases to participate in the pension), pots become ‘deferred’ (not contributed to) and must still be administered by the pension provider. A substantial number of these deferred pots are very small, meaning that they are expensive to administer. And when an individual moves to a new employer, it is often the case that this leads to a new pension being opened. So over a lifetime an individual could end up with several deferred small pension pots, which are therefore hard for individuals to keep track of and to manage well. This report discusses the problems with this system and the merits of different potential policy responses.

Key findings

1. The number of deferred small private pension pots is large and growing. In 2023, there were around 20 million defined contribution (DC) pension pots worth under £10,000 which are no longer being contributed to. In aggregate, these contained almost £30 billion. Over half of these pots, 12.1 million, were worth under £1,000, containing, in aggregate, over £4 billion of investments. These numbers have increased rapidly in recent years and are likely to continue to grow without policy action. For example, based on information from five large pension providers, the number of deferred pots worth less than £1,000 increased by almost two million from 2020 to 2023.

2. The proliferation of these deferred small pension pots is burdensome for savers and pension providers. Smaller pots are uneconomical for pension providers, with there being some fixed costs of administering pots, leading to higher charges and therefore lower returns for savers. In addition, having several, or potentially many, small pension pots, rather than one big pension pot, makes managing saving and drawdown decisions harder for individuals, and increases the likelihood of them losing track of a part of their savings. The introduction of Pensions Dashboards, an online tool
being developed by the government for people to access information about all their pensions in one place, should help people keep track of how much they have saved, but will not necessarily lead them to consolidate their pensions appropriately and make good saving and drawdown decisions.

3. Lower earners and women are particularly likely to accumulate small pension pots. Our illustrative modelling exercise suggests that, over a nine-year period, almost three-quarters of pension pots accumulated by the lowest third of earners will be worth under £5,000, compared to one-fifth of pots accumulated by the highest third. Over half of pots accumulated by women will be worth under £5,000 compared to one in three pots accumulated by men. The key drivers of the generation of small pots are low levels of earnings (for example, through working part-time), low rates of pension contributions, and individuals moving from one employer to another.

4. The status quo is not fit for purpose. We judge there is a strong case for deferred small pension pots to be consolidated by default, with people being given the option to opt out of this consolidation if they wish. This would reduce the stock of uneconomical pension pots, benefiting savers and providers. It could also make it easier for individuals to manage their pensions as they would be spread over fewer pots and, importantly, it need not change the administrative burden on employers. This could be implemented through the creation of a central clearing house.

5. Individuals who have more than one pot with the same pension provider should have these pots automatically consolidated together. Individuals can have multiple pension pots administered by the same pension provider, for example relating to two or more different employment spells for different employers. These different pots can have different fee structures and individuals should ideally have all funds, regardless of pot size, consolidated into the pot that represents the best value for money. The case for this same-provider consolidation will become even greater if the DC pension market becomes more concentrated over time.

6. Besides same-provider consolidation, there are a number of decisions to make about the implementation of automatic consolidation of deferred small pension pots, including which size of pots should be automatically consolidated. As smaller pension pots are typically more uneconomical to provide, the case for consolidation is strongest for the smallest pots. But also consolidating larger pots would lead people to have their savings spread across fewer pots as they approach retirement, which would help them make sensible decumulation decisions. There would nevertheless be a benefit to limiting the number of pots that are automatically consolidated initially to assess any potentially anti-competitive effects of the reforms on the market, as well as the costs associated with moving pots. Therefore, only deferred pots below £1,000 should be automatically consolidated initially, but this limit should ideally be raised over time and should also, in the long run, be subject to regular and frequent increases to avoid it falling behind inflation. It should also be easy for individuals to choose to opt into having their larger deferred pots consolidated too.

7. Another key question for implementation is which pot the deferred small pots should, by default, be consolidated with. The two most sensible policy choices are either to use one of a set of government-approved consolidator arrangements (often referred to as ‘default consolidator’), or to consolidate into a member’s current pension (often referred to as ‘pot follows member’). Ultimately, these options have many similarities. In our judgement, both pot follows member and the default consolidator approach would be a significant improvement on the status quo.

8. The choice between default consolidator and pot follows member interacts with the size limit for deferred pots. A higher size limit in the default consolidator model would lead to more pots being consolidated into a small number of funds – this anti-competitive effect might limit how high the limit can be set under this approach. Under pot follows member, raising the size limit indefinitely would eventually lead a member’s pension pot to always follow them when they change employer. This might have the benefit of increasing members’ engagement with their current pension, and it would ensure that their pension was not with an outdated provider, but there could be issues with the associated flow of funds between providers. This could be mitigated by having the limit increase once individuals are within, for example, ten years of reaching their state pension age, although it is not clear that the pension fund associated with the final employment spell would necessarily be the best destination for everyone’s pension savings. There are definitely advantages to the pot follows member approach, but the preferred policy will depend on the weight policymakers put on ensuring all individuals end up with a single pot by retirement as well as the government’s aims for the future structure of the DC market.

9. Allowing employees to choose where their employer should send their pension contributions – ‘member choice’ – would also help prevent the creation of new small pension pots as employees using this option would likely ask their employers to send pension contributions to an existing pot if they have one. A ‘lifetime provider’ model takes this further by automatically having contributions for each employee sent to a ‘lifetime’ pot. These policies have merit if savers can choose a more appropriate pension plan for themselves than their employer. The lifetime provider model would ensure people end up with one DC pot at retirement without a significant constant flow of funds between providers. However, they would create extra hassle for employers, and could lead to increased fees, particularly for those with smaller pots. And there will be concerns that, left to their own devices, some will end up with a worse deal than what their employer would have been able to negotiate on their behalf. We judge that member choice and lifetime provider solutions should only be considered after fully implementing policies to consolidate deferred small pots automatically.