Dormant UK pension pot numbers have risen to a record high of 18 million.
When eligible workers start a new job, they are automatically enrolled, and when they leave that job for the next one, their pension pot stays where it is.
Continually changing jobs, low pension contributions and a large number of providers operating in the UK pension market is causing a surge in small pension pots.
It has negative consequences for savers as people risk losing touch with their pension pots as they move through their careers in the job market.
Costs increase as well as small pension pots proportionately are more expensive to administer, and they are a burden on system wide efficiency.
There was a proposal for a system whereby pension funds would follow people from job to job named ‘Pot-follows-member’, however it failed for two reasons: first the high unit cost of a UK pension transfer which is estimated at £100 split evenly between the ceding and receiving scheme.
Second, the proposed system was impossible to secure against fraud by shameful employers.
Although this failure highlighted that any small pots solution in the future will need to reduce the unit costs of transfer to pennies and will need watertight security.
It will also need to ensure that any solution is automatic and removes the need for human intervention.
In Australia superannuation already has the functionality for people to voluntarily consolidate their ‘lost’ pension pots through the country’s pensions dashboard, or have their trust-based provider do it for them.
Australians do not do this very much and we have no reason to think that British citizens would be any more motivated.
Contract-based pension providers have been pushed hard by government and the regulators to get their act together following the bruising 2013 Office of Fair Trading report into the sector.
On the trust-based side, master trust authorisation is now a reality. All eligible schemes operate inside a charge cap.
The regulation of retail pensions however is much weaker.
So any solution to small pots that risks opening the floodgates to a rush of pension savings from lower-cost, better-governed workplace pensions, into more expensive retail pension products would have unintended consequences.
Costs matter so much over the long term of a pension saving arrangement.
There are some factors limiting the growth of small pots. Some pension schemes operate a ‘single pot’ model.
Both Nest and The People’s Pension ensure people who are re-enrolled back into these schemes keep saving into their old pot, preventing the growth of small pots.
Additionally, the pensions market is consolidating.
Master trust authorisation has more than halved the number of master trust schemes and we expect consolidation in the single employer trust space to continue.
The Department for Work and Pensions could help handle the small pot problem by further forcing the pace of consolidation, following their consultation paper on the issue earlier this year.
But neither of these propositions is the answer to the problem.
Soon the pensions sector will need to come together to find a solution to the small pots issue and prevent the problem developing further.