Does a pension pot for life work for employers?

Ever since we started discussing automatic enrolment, 18 years ago, we have known the creation of a multitude of small, neglected pension pots was going to be an unfortunate side effect.

And for the last 18 years, we have been discussing possible solutions to this problem, often circling around to ideas previously put forward, to see if this time it would be different, and they could work.

The government has now decided to grapple with this problem face on. It wants to reduce the number of small pots already created by putting in an approach that will automatically consolidate workplace pension pots of less than £1,000 that haven’t been paid into for a year.

But it’s also keen to see if it can stop the small pots from being created in the first place.

It has launched a call for evidence to consider a two-phase approach. The first will be to give employees the right to ask their employer to pay their automatic enrolment contributions into a pension scheme of their choosing.

The second phase is to take this idea further, so that every time someone joins a new employer their pension contributions will automatically be defaulted into the individual’s previously chosen pension plan. No action is needed by the employee. No requests to make or forms to fill in. The contributions will automatically be paid to their lifetime provider.

Now, don’t get me wrong. I am a strong advocate for giving people choice. Choice engages people with their pension saving, leading to increased contributions, higher investment returns, and better decumulation decisions.

But although these proposals have been positioned as increasing member choice, I think they will have the opposite effect. They threaten to create a world where someone chooses their pension provider at the age of 18, and then sticks with them for their whole working life, never experiencing anything else. Very similar to how some approach picking a bank account today, where apathy prevents them from switching.

What’s more, asking employers to pay automatic enrolment contributions to two or many more providers is going to create an enormous administration headache for them. They will have multiple providers to communicate with each month, enrol members into, and sort out any administration niggles. Getting the right contributions to the right provider for the right person is an absolute minimum.

We cannot ask them to do this until we build a strong system solution. But there has been no real investigation into how this could work in practice, or indeed, what minimum features employers and providers need. A lot of faith is being placed on building on the back of other technology developments – but so far, the pensions dashboard is only partly built, and the clearing house to support small pot consolidation has yet to make it to the design board. We have a long way to go until we can realistically think about taking this forward.

Such infrastructure won’t come cheap. (Maybe one of the reasons it hasn’t been attempted in the last 18 years.) But before we tally up the costs to pass to members and employers, we need to balance them against the benefits. Only a very small number of members will take up the offer of asking their employers to pay contributions elsewhere. Is it really worth the effort?

Finally, these proposals risk creating an environment where there are fewer pension schemes competing against each other, and where the barrier to entry to the market will be high. To compete against these legacy providers, new companies will need substantial funds to foot the marketing bill and entice in new members. A market where there are fewer disrupters or new entrants easily moves the power dynamic away from the individual.

Ultimately, the one thing that will most help more people achieve a better income in retirement is to encourage them and employers to pay higher pension contributions. Consolidation may help here, but it isn’t the biggest driver. We need to instead concentrate on that end goal and what is needed to achieve it.