Re-piping the pensions infrastructure for small pots

Back in the 1860s the most extraordinary sewage system was built under London. To cut costs, it used the same enormous pipes to take away all of the capital’s rainwater and sewage.

Now that London has a population of nine million and the UK is experiencing greater rainfall, the system struggles to cope. Had rainwater and sewage been treated separately it might have helped, but the system is no longer adequate.

This subterranean “legacy problem” is a metaphor for the UK pensions system. Were we building it from scratch today, we would do it differently. Were we building it from scratch today, it would be easier to do it differently. But we are not.

Much was made in the wake of the Autumn Statement about the single pot idea – the so-called “pot for life”. But this is going to take a long time. The pot for life still does nothing about the millions of small pots that exist today. We must consider consolidation too.

The government knows this and is on the case. Buried in the 114-page full statement was reference to another ongoing discussion: “The government will also introduce the multiple default consolidator model to enable a small number of authorised schemes to act as a consolidator for eligible pension pots under £1,000.” This follows from the previous consultation and the Mansion House speech.

According to that small pots consultation response, there are currently 12.1 million deferred pension pots under £1,000 – and this is likely to rise to 27 million by 2035, with the average worker expected to have 11 separate pension pots by the time they retire, according to the FT. The ABI suggests that there are over 2.2 million with under £1,000 currently held within contract-based schemes. Members easily lose track of these smaller pots, but their value adds up. It is estimated that over £26 billion is sitting in lost pension pots (PPI Briefing Note Number 134: Lost Pensions 2022: What’s the scale and Impact?). Action is urgently needed.

It is very difficult for pension providers to administer small pots efficiently. The Small Pots Cross-Industry Co-ordination Group estimates that the continued growth in the number of small pots by 2030 could result in wasted administration costs of around a third of a billion pounds a year. There is a very real likelihood here that larger potholders are cross-subsidising their smaller counterparts.

In its call for evidence in July last year, the DWP explored two solutions for large-scale automated consolidation: “pot follows member” and a default consolidator model. Members, employers and providers alike should benefit if either of these can be made to work.

Both models have advantages, but surely only a default consolidator breaks the inertia problem. “Pot follows member” requires the member to do something for consolidation to happen, whereas they do not have to do anything under a consolidator.