A decade of inaction on small pots – and the impact on member engagement 

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The pace at which small DC pots are increasing in both number and combined assets is a pressing challenge for the UK pensions industry. While the Department for Work and Pensions (DWP) has now put a plan in place to fix this, the bar may be set too low. Unfortunately, government and industry could have started solving this problem 10 years ago – and the impact of this inaction has been detrimental to member engagement. 
 

A lost decade in legislating for small pots 

 
The Pensions Act 2014 introduced Clause 33, which covers the automatic transfers of pension benefits. The clause ‘requires the Secretary of State to make regulations under which […] the cash equivalent of a person's accrued rights to benefits under a pension scheme must be transferred to another scheme of which the person is an active member’, or to be merged ‘in certain circumstances.’ 
 
This gave the UK government an ‘enabling power’ to draw up detailed secondary legislation to cover the details of how DC pot consolidation would work. However, a decade later we have not made much progress. Could UK DC savers afford another decade of inaction on small pots?
 

Firmly on the regulatory roadmap – but the bar is set low

 
DWP’s response to the consultation on addressing the proliferation of small pots suggests a ‘multiple default consolidator’ approach, but only auto-enrolment pots sub-£1,000 which are invested in charge-capped default arrangements will be in scope. Under this approach, members will have to choose among several authorised default consolidators. If no choice has been provided, the pot would then be sent to a consolidator where the member has a pot already – or has the largest pot if they have several. 
 
However, this approach is unlikely to stop new small pots from arising. This is why DWP is currently collecting evidence on the ‘lifetime provider model.’ Given the recent change in government and Labour’s current plans for a pensions review focused on unlocking capital in DC and LGPS schemes for UK growth, there is a risk that nothing will happen for a while.
 
The lack of urgency is particularly concerning given that DWP has already documented the pace at which small pots are increasing in both number and combined assets in its consultation:
 
 

Small pots have a small impact on outcomes – but what about member engagement? 

 
Using Hargreaves Lansdown’s pension calculator (one of many available to DC savers), we can calculate the outcome for a hypothetical worker who has graduated from university at age 23 and got their first job at age 24 and a salary level of £30,000. 
 
This hypothetical worker is currently 27, grossing £35,000 per annum in their new job and has since the start of their career contributed the minimum required under auto-enrolment (the 3% minimum from the employer and the remaining 5% from the employee). Let’s also assume that this person switched jobs twice before age 27, so they have two pension pots, roughly equal in size and totalling £6,000.
 
If the worker were to retire at the age of 67 and take out 25% in tax-free cash thereupon, this is what they may end up with:
 
Source: mallowstreet

Interestingly, the two DC pots totalling £6,000 are unlikely to qualify for automatic consolidation under the proposed small pots legislation. Omitting these two pots could cost this person £10,000 at retirement, which reduces their tax-free lump sum by £2,600 and their income for life by £400 per year. The impact may not be life-changing but cannot be neglected. 
 
However, a potentially worse outcome may be that the worker would be less engaged with their pension at a key point in their career. Small pots are difficult to account for mentally and manage meaningfully, as highlighted in Section 1.10 of the DWP call for evidence on small pots. So, our hypothetical worker may ignore these pots, cash them in, or worse yet – forget about them altogether and let them erode under the higher fees which are sometimes charged on deferred pots after members leave the scheme. 
 

Could small pots consolidation drive greater engagement and better outcomes? 

 
Now let’s assume that the opposite happened, and the worker became more engaged with their pension after consolidating the starting pots to the more substantive sum of £6,000. Under this scenario, the worker increased their personal contribution from 5% to 8%, which, together with the employer’s 3%, results in a total of 11%.

Source: mallowstreet
 

The worker would be £55,000 better off in retirement and increase their annual income by £2,500, which is about £208 extra per month. This scenario is not too distant from the proposed increase of minimum auto-enrolment contributions to 12%. 
 

DC outcomes at DB contribution levels reveal a glaring gap in adequacy

 
What would these outcomes look like if employers kept contributing at similar levels to DB arrangements? The Pensions Policy Institute analysis from 2021 indicates that DB arrangements used to require about 20%-25% in contributions, split between employers and employees. Assuming a contribution rate of 22% in the HL pensions calculator, this would give our hypothetical worker an annual retirement income of £32,900.  
 
Source: mallowstreet
 

A call to accelerate regulatory change 

 
While many in the UK pensions industry support the idea to increase minimum auto-enrolment contributions from 8% to 12%, even then DC outcomes may be inadequate for many. It is imperative for industry professionals and their providers to explore all avenues – both those relying on inertia and greater member engagement. It is the careful balance between these forces that has made auto-enrolment a success, so why ignore one side of the equation now?

This article has been prepared with simulated data for salary sacrifice arrangements, prepared on 09/08/2024 and provided by Mark Laurie, a certified payroll professional.
 
*When calculating retirement pots under different scenarios, we used the Hargreaves Lansdown pensions calculator. However, as it is intended for SIPP and retail clients, it does not take into account qualifying earnings limitations under auto-enrolment, so the figures show higher than expected retirement outcomes because they are based on the full pensionable earnings. 
 
There are many pensions calculators available online, each with their own assumptions and calculation methodology. The level of transparency they offer will also vary. mallowstreet does not recommend any specific pensions calculator. 


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