Two major developments in pensions are likely to lead millions of savers to consider consolidating multiple smaller pension pots into one larger pot.
The first is automatic enrolment into workplace pensions which potentially gives workers a separate new pension each time they change job. The second is the pensions dashboard which will enable people to see all the different pensions they have built up over their life in a single place. In both cases there will be a natural tendency to want to ‘tidy things up’ by consolidating small pensions in one larger pot.
But Royal London Director of Policy Steve Webb has issued a warning to savers to think carefully and seek expert advice or guidance before consolidating to avoid inadvertently making themselves worse off. Royal London have identified ‘five good reasons’ to think twice before consolidating small pension pots:
- Throwing away enhanced tax free cash or early retirement options attached to old pensions – some pensions, especially those taken out before ‘A day’ in 2006, allowed members to draw more than 25% of the pot tax free or to access the pension before age 55; if these pensions are transferred out individually, those privileges can be lost;
- Throwing away ‘guaranteed annuity rates’ attached to older pots – when some pensions were sold, they carried a promise that the pot could be turned into a guaranteed income in retirement; given the collapse in annuity rates in recent years these guarantees are extremely valuable but can be lost if people simply transfer out into another pension;
- Paying ‘exit penalties’ when combining pension pots – whilst modern pension policies can generally be merged without penalty, savers can face exit charges if they want to take money out of older policies;
- Missing out on ‘small pot’ privileges for those with lifetime allowance issues – accessing a pension generally counts against your lifetime allowance (currently £1.055m); but savers are allowed to take up to three ‘trivial’ pots of under £10,000 without counting against the LTA; those who retain small pots rather than combining them effectively add £30,000 to their LTA;
- Missing out on ‘small pot’ privileges for those still saving into pensions – taking taxable cash from a defined contribution pension triggers a cut in the saver’s annual allowance from £40,000 to £4,000 via the ‘Money Purchase Annual Allowance’; but taking a small pot under £10,000 does not do so; those who consolidate all their small pots miss out on this privilege.
Commenting, Steve Webb said:
“One of the questions I am asked more often than any other is whether people should combine all of their pensions in one place. Whilst that may seem the tidiest thing to do and can have some advantages, there are also a number of unexpected disadvantages to merging pension pots. Older pension policies may have attractive features which would be lost if transferred, whilst small pots benefit from certain tax privileges which do not apply to larger pots. As ever, the best approach is to talk to seek impartial advice or guidance before consolidating pension pots”.