The Institute for Fiscal Studies (IFS) has called for government intervention to address the growing issue of small pension pots in the UK. The think tank argues that the proliferation of these pots, which are often left behind when employees change jobs, is causing problems for both savers and pension providers. According to the IFS, there were around 20 million defined contribution (DC) pension pots worth under £10,000 each in 2023 that were no longer receiving contributions.
More than half of these pots, amounting to 12.1 million, were valued at less than £1,000. The collective value of these small pots is over £4 billion. The IFS believes that the current system is not fit for purpose, as it leads to increased costs for pension providers and makes it difficult for savers to manage their retirement funds effectively.
Mubin Haq, chief executive at abrdn Financial Fairness Trust, stated, “Further action is needed to reduce the complexity of managing small pension pots, which should result in gains for employees as well as providers.”
The think tank suggests that there is a strong case for automatically consolidating these small, deferred pension pots. This would involve combining pots that are no longer receiving contributions, either within the same provider or into a single pot that follows the member throughout their career.
Automatic consolidation for small pension pots
Laurence O’Brien, a Research Economist at the IFS, warned, “Without policy action, many will end up with their savings scattered across several small pots by the time they reach retirement.”
The IFS recommends that automatic consolidation should initially focus on pots below £1,000 to limit market distortions and monitor the impact on providers. The threshold could then be raised gradually to keep up with inflation and other economic factors. Lower earners and women are particularly affected by the issue of small pension pots.
The IFS found that over nine years, nearly three-quarters of the pension pots accumulated by the lowest third of earners are expected to be under £5,000, compared to one in five for the highest earners. More than half of the pots accumulated by women are expected to be below £5,000, compared to one in three for men. The introduction of Pensions Dashboards, an online tool to help people access information about all their pensions in one place, may help to some extent.
However, the IFS argues that this will not necessarily encourage proper consolidation and management of pensions. The government is now being urged to consider the IFS’s proposals seriously and take necessary actions to implement policies that support the automatic consolidation of small pension pots. This could help to simplify the pension landscape, making it easier for savers to manage their retirement funds and reducing administrative costs for providers.
