As the roll-out of auto-enrolment continues, thoughts have started to turn to the future impact of this mass registration.
The Government has estimated that without reform, auto-enrolment will create up to 50 million dormant pension pots by 2050 and the removal of the option to take small pots as a short service refund will only exacerbate the situation.
Having millions of small, dormant pension pots is clearly inefficient for both schemes and members, so the question is: what is to be done?
The Government has proposed an automatic transfer system known as “pot follows member”.
Simply put, when a member leaves an employer, his pension fund will be automatically transferred to his new employer’s scheme.
Pension pots worth over a certain amount (proposed at £10,000) would be excluded and the member would be entitled to opt out if they wish.
I like the principle behind this idea.
We often see clients who have moved from job to job and accrued small funds in a variety of schemes. This can result in both a lack of awareness over what their final pension will be worth and an incoherent investment strategy.
Also, while the Department for Work and Pensions estimates that there is currently £3bn sitting in “lost” pension funds, this figure would surely rise significantly as a proportion of the 50 million dormant pots created by auto-enrolment are simply forgotten.
So while I am happy with the principle of the idea, I have concerns about how it would work in practice.
Having a transfer process for members will create administration costs on the provider side. If these costs were explicitly applied to the member on small pots, they would create a disincentive to transfer.
But the alternative is that costs are absorbed into schemes and applied to all members. This system could create a conflict of interest for the provider because it may wish to keep accrued funds under management for itself.
This could manifest into poor administration because there would be little incentive to invest into the process, which could result in out-of-market risk for savers.
More importantly, this proposed approach does, for me, pose a fundamental question: are all pension schemes the same?
The answer is no. Different schemes have different charges, governance and features and while they may be similar, they are not completely homogenous products.
The anticipated DWP charge cap may level the playing field but the danger still remains that these rules will forcibly move savers’ money from higher-quality pension schemes into lower-quality and higher-charging schemes.
Members may have received advice or guidance when setting up a plan and be following an investment strategy. How would this be affected by an automatic transfer?
They may be moved from a target date fund into a cautious managed fund or vice versa. How will the relative merits be explained?
As an adviser, the Financial Conduct Authority guides us that we should not consolidate pensions for consolidation’s sake; rather, we should demonstrate the member benefits of any switch. I am not sure that the pot-follows-member rules, in their current format, would satisfy this criterion.
Finally, with the efficiency and indeed the future of the annuity market under the spotlight at present, it is important to consider what will be at the end of the road for the member.
As the FCA’s Valentines Day annuity review has highlighted, the benefits of shopping around at retirement can greatly increase retirement incomes.
If a scheme is to be used as a receiving scheme under pot-follows-member, it must ultimately ensure that the member receives the guidance and advice required to make the most of their pension savings.
Mark Pearson is business development director at Origen Financial Services