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Small pot, big problem

After a year of intense consultation on pensions and tax reform, most of the changes are now agreed and many are already implemented. Yet to be decided are the rules on occupational pension scheme preservation, which allow refunds to be made to members who leave a scheme with less than two years’ pensionable service.

The Department for Work and Pensions consulted on this earlier this year and an interim response was published in June with more to follow in the Autumn. The consultation provided a few clues towards where we might be headed. It said: “We are not convinced short service refund rules support the objective to help people save. We do recognise the value of existing short service refund rules. Removing them would increase the number of small pension pots.”

This might suggest the days of short service refunds are numbered but any decision to proceed in that direction hinges on a solution being found to deal with small pots.

There are three options here:

Keep the existing rules, requiring member consent to transfer a small pot. This would have to be accompanied by improved processes for transfers as the existing system is not fit for purpose.

The solution might look something like the options transfer system now widely used at retirement, where standardised forms and common IT protocols ensure money moves from A to B much quicker than before.

The second option requires all small pots to be transferred to Nest. This has the advantage that the existing scheme knows exactly what to do with the ex-member’s fund and Nest could build systems to allow trustees and scheme managers to move money and obtain legal discharge easily.

The downside of this is that a number of changes to the law would be needed. Terminating a personal pension without consent and transferring it to another pension scheme must not be regarded as an unfair contract term.

The final option is to transfer small pots without consent to the new scheme a member ends up with. The legal issues are similar to option two but with one or two nuances.

Those in favour of keeping the existing short service refunds rules argue it is expensive to keep small pots. If one of these solutions is found capable of dealing with the issue, that argument falls away.

That still would not mean short service refund rules necessarily need to change. An alternative would be to transfer rather than refund the default, similar to auto-enrolment, where membership of a pension scheme is the default condition.

That would avoid yet another expensive change to pensions administration systems that have already been subjected to invasive surgery as a result of a host of legislative changes.

John Lawson is head of pensions policy at Standard Life


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