UK government urged to consolidate small pots by default

The Institute for Fiscal Studies (IFS) has urged the UK to take action “to stop and reverse the proliferation of millions of small pension pots”, such as default consolidation of small pots.

The IFS found that in 2023 “there were an astonishing 12.1 million defined contribution (DC) pension pots worth under £1,000 which are no longer being contributed to”.

In aggregate, these contained over £4bn (€4.8bn). These numbers, according to IFS, have increased “rapidly” in recent years and will continue to grow further without policy action.

The institute said the proliferation is “costly” for pension providers due to the fixed costs of administering a pension, leading to higher charges and lower returns for savers. In addition, having savings spread over many small pension pots makes it easier for people to lose track of their savings, and harder to make sensible decisions on how to use their wealth through retirement.

Therefore, the institute argued 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, according to IFS, would reduce the stock of uneconomical pension pots and it should make it easier to manage their savings.

It suggested this could be done by automatically moving all the money in someone’s deferred small pension pots into either the scheme run by their current employer or into a number of default funds. This, it added, would not increase the administrative burden on employers.

IFS said there are merits of going even further than just consolidating small pots, and moving towards a system where people end up with one DC pension pot, or only a very small number of these, as they approach retirement.

This option would help people make good decisions on drawing their pension savings through retirement. There are several ways to achieve this, according to IFS, each with its own set of trade-offs and potential impacts on the DC market.

It said the preferred policy will depend on the weight policymakers put on ensuring all individuals end up with a single pot as well as the government’s aims for the future structure of the DC market. For example, a system where an individual’s past DC pots all, by default, move into their most recent pension pot – known as ‘pot follows member’ – would have many advantages.

Laurence O’Brien, a research economist at the IFS, said that while automatic enrolment has been a huge success in getting more employees to save in a pension, without policy action, many will end up with their savings scattered across several small pots by the time they retire.

She said: “This status quo is not fit for purpose: it is uneconomical for pension providers, leading to higher charges for savers, and it makes it harder for individuals to make good decisions on how to use their savings.”

O’Brien called on policymakers to help savers out by ensuring that, by default, their deferred small pots are consolidated together.

“This would lead to lower average charges and make it easier for individuals to keep track of all their savings. One potentially attractive option is for an individual’s pensions to be combined, by default, into their most recent pension. What is not attractive is the status quo that generates many millions of pensions worth under £1,000,” she said.

Joe Dabrowski, deputy director of policy at the Pensions and Lifetime Savings Association, said the industry and the Department for Work and Pensions have spent “considerable time and effort” examining the small pots issue and are working hard on a multiple default consolidator solution, which will form part of the Pension Schemes Bill.

He said: “Future consolidation of the defined contribution pension market can be expected to lead to greater pot consolidation over time, while pensions dashboards will, once launched, help savers find information about all their pension provisions in one digital place.”

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