Girish Menezes argues that transferring small pension pots from employer to employer is not always the most efficient action

There is a myth around small pension pots. To clarify this myth, let's focus on Sam's story, who meanders through life, working a year or so in low paid jobs at fast food restaurants and departments stores, leaving a swathe of small pension pots behind. This apparently is terrible value for money and the government is determined to rectify this by ensuring that the pension pots follows Sam, much like Mary and her little lamb.

However, this is based on a fundamental misunderstanding of pensions and charging structures.

Assuming that Sam is in an insured pension, where charges are based on a percentage of assets under management, she is most likely to be charged the same percentage, regardless of the size of the pot.

So 1% of a GBP 500 pot would be GBP 5, and the CFO of the company she worked for could potentially be paying GBP 5,000 on a pot of GBP 500,000. Neither party is paying the typical administration cost of GBP 30 on average. Sam does not actually gain financially at all by consolidating her pot, she will merely have to pay for any costs associated with the transfers.

Let us take a different scenario, in which Sam was lucky enough to join a firm with a trust-based pension scheme. Not necessarily a non-contributory defined benefit pension arrangement, but a far more standard NAPF-style pension quality mark awarded defined contribution trust-based arrangement.

On leaving her GBP 500 pot behind, Sam actually pays nothing at all for the administration and governance of her savings as most trust-based arrangements get their administration costs picked up by the sponsor of the scheme. Transferring out is just a cost.

So what is the true cost for Sam if the pension pots followed her every change of employment? The industry generally puts a value of GBP 100 to GBP 150 on each transfer, which is a big bite out of Sam's GBP 500 of savings. Not exactly helpful.

Of course, that is not the entire story, as buying and selling of the underlying assets that Sam's savings are invested in will reduce her savings even further. The government would like the industry to charge Sam GBP 10 per transfer. That leaves a big balance of cost for the industry to swallow for every transfer, but with not much benefit for Sam.

Of course, the value of a following pot is not merely financial. Small pension pots are usually forgotten, unloved and therefore unappreciated. The government, industry and sponsors believe that the consolidation of pots will increase the perceived value of the pension pot in the eyes of the member?in this case Sam.

PASA believes the pensions industry should address the issue of communication instead of consolidation. Rather than buying and selling Sam's assets and physically moving her pension pot from employer to employer, would it not be more beneficial to be able to have a consolidated view across her pension arrangements.

The alternative of putting all her pension in a consolidated pot not only loses her money but also potentially increases risk. Naturally, if the charging structure was changed so that Sam was in a worse position with a small deferred pot, she always has the flexibility to transfer out.

We support those who have been lobbying for some time to have a database of pension pots, potentially with a member's National Insurance number as the key identifier. This ensures that pension administrators can virtually consolidate Sam's pension savings and communicate this to her on a single web page and a single benefit statement, as well as allowing her to model retirement outcomes in a single modeller.

At retirement, she can then base her decumulation decisions on her entire pensions savings, but have more flexibility around consolidating, liquidating, annuitising or spending her various pots. This would be incredibly valuable to Sam and would be far more cost effective for her and the industry, as opposed to the enormous costs resulting from pension pots following member.

Written by Girish Menezes, Pensions Administration Standards Association (PASA) and member of the PASA Policy and Strategy sub-committee

Girish.Menezes@xerox.com

First published - 21.11.2014