Small pension pots consultation response: pots of gold?
In a development that surprised many in the industry, the Government last week announced that small defined contribution (DC) pension pots built up through auto-enrolment will transfer automatically to the new employer’s scheme when an individual moves job. Further details are set out below.
With the advent of auto-enrolment, the number of small pension pots is set to increase dramatically. The Government is concerned that many people may lose track of their pension savings as they change employment over time. As a result, in December 2011, the Department for Work and Pensions (DWP) issued a consultation paper “Meeting future workplace pension challenges: improving transfers and dealing with small pension pots”. This paper looked at three possible options for dealing with small pots:
- improving the current regulatory framework so as to encourage more voluntary member transfers,
- introducing automatic transfers of small pension pots to one or more central “aggregator” schemes, and
- introducing automatic transfers of small pension pots to the new employer’s scheme when an individual moves job.
The consultation response
On 17 July 2012, the DWP published the response to its consultation, announcing that it has decided to pursue the “pot follows job” approach (option 3 above). This will not, however, be a universal rule applying to all schemes and members. Instead, it is proposed that automatic transfer from one employer’s scheme to another will:
- apply only to pots created in auto-enrolment schemes,
- apply only to pots valued below a certain limit (the limit is yet to be decided but figures mentioned in the consultation paper range from £2,000 to £20,000),
- not apply to defined benefit (DB) pension rights (because this would present very significant, potentially insurmountable, challenges), and
- not apply, at least initially, to existing dormant pension pots (the fact that legacy schemes sometimes provide for favourable annuity guarantees and material exit charges was cited as reason for omitting these for the time being, though this may in future change).
Some other key points arising from the consultation response are summarised below.
Advice - The automatic transfer of small pots will not require financial advice. This is because the receiving scheme would have to satisfy the qualifying requirements to be an auto-enrolment scheme. It was also felt that it could be disproportionately costly to take advice on small pots.
Opting out - Members will have the right to opt out of automatic transfers.
Short service refunds/micro-pots - Occupational pension scheme members are currently entitled to choose a refund of their contributions if they leave the scheme with less than two years’ pensionable service. The Government reiterated its plan to abolish so-called short service refunds for occupational DC (but not DB) schemes. An exemption for refunds of “micro-pots” (pots so tiny that they would not be worth transferring) will be considered; figures ranging from £50 to £200 have been mentioned.
Virtual tool - The Government plans to work with industry on a “virtual pot solution”. This would be an amalgamation tool to help individuals see all their pension pots, regardless of size, in one place.
Other regulatory changes - It is proposed that improvements will be made to the current voluntary transfer framework, with a working group being established to explore the scope for this.
The Pensions Minister stated that the Government has chosen “the more ambitious option” here. The aggregator scheme approach (or simply making some amendments to existing regulation) would have seemed more straightforward both for the Government to implement and, crucially, for employers and trustees to put into practice. At least in the short term, the proposed approach would seem to add to the administration and cost burden on them.
The Government believes that this cost will be outweighed in the future by the savings made. We assume that this relates to the alternative of otherwise having to administer a greater number of dormant pots.
The ambitious option was chosen despite the fact that the majority of consultation respondents (over 60%) expressed a preference for the aggregator option, while “pot follows job” achieved only 21% support. The DWP appeared to be influenced by research from the Association of British Insurers suggesting that 58% of people would like their pot to move with them as they move employment, compared to just 10% wishing their pot to move to an aggregator scheme. There was also a concern that an aggregator scheme (or schemes) may not lead to real consolidation and could potentially distort the market, particularly if a commercial aggregator scheme failed.
Some parts of the pensions industry do not agree with the DWP’s proposed approach. The National Association of Pension Funds has called for the Government to reconsider, and Age UK, the TUC and Which? have issued a joint statement in which they say they are "extremely concerned" by this approach.
The consultation response has only scratched the surface of the issues that will need to be addressed before this proposal becomes law. A significant potential pitfall is the risk that the receiving scheme performs less well than the transferring scheme. Employers and trustees will be keen for the Government to assist in minimising the risk of claims against them as a result of automatic transfers to or from their schemes.
The position of those with multiple jobs, those with gaps between jobs, the self-employed, earners below the qualifying earnings threshold for auto-enrolment and those who move to an employer using a DB scheme as its auto-enrolment vehicle will also require consideration. There may also be broader issues to overcome around interaction with existing legislation, particularly consumer protection and auto-enrolment rules.
The fact that DB pension rights have been excluded from the scope of automatic transfers is very welcome. There is likely to be debate, however, over what constitutes a DB right in this context, particularly due to the new (but not yet in force) statutory definition of “money purchase benefits”.
The consultation response does not specify a proposed implementation date for these reforms. Given the complexity of the issues to be addressed in finalising this ambitious plan, implementation may well take some time.