LCP, a pensions consultancy that counts former pensions minister Sir Steve Webb amongst its employees, has published a guide looking at the pros and cons of someone combining all their pensions in one pot.
To a certain extent, the guide is aimed at those looking to consolidate their workplace pensions, but the points covered can apply to all pensions.
What were the potential advantages?
Potential to pay lower charges
Where a worker has been automatically enrolled into a workplace pension and hasn’t made any specific choices of how they want to invest the contributions, the scheme will invest them into a ‘default fund’ where overall charges cannot exceed 0.75% pa.
The guide points out that many pensions charge a lower level of charges than this. The types of plans we recommend cost between 0.45% to 0.55% per annum (this does not include any costs associated with getting financial advice).
Rationalising your overall investment strategy
This is a significant driver for bringing pots together. Clients tend to have many pots with no real overarching investment strategy. In many cases, these investments take a far more aggressive approach than would be suitable for the client.
Not missing out on innovations in investment approaches.
This is a driver for clients wanting to consolidate but can amount more to a “fear of missing out”. Our approach is about doing the simple things well. We ignore the “fads” the report lists as reasons to consolidate, such as investing in infrastructure. Many older plans charge the people with money in them a lot for not doing that much.
Better value when buying an annuity
The report illustrates that the more money you have, the more income you can buy when buying an annuity. However, we have recommended annuities where the source of funds can come from multiple plans.
Easier to manage & engage with your pensions
With many older pensions, the only way to get any information out of them is to stay on hold on the phone for a stupidly long time to get through to a call centre. Even then, you may have to wait several days before you get what you have asked. Modern pensions give you all this information quickly online, avoiding the need to waste a day ringing up different providers.
What were the potential disadvantages?
Loss of Guaranteed Annuity Rates
Some older plans offered a specific rate if you bought an annuity through them, and these rates are generally better than what you can get on the open market. If you have a pension that has a GAR or other benefits that the guide does not mention, such as Guaranteed Minimum Pension, you need to take great care.
Loss of small pot privileges
The report mentions how smaller pots have minor privileges that could be lost if combined with a bigger pot. These privileges only apply rarely and can be replicated using specific pension plans.
Loss of tax protections – ‘A Day’ protections on tax-free cash, age of access
Specific plans that predate 6th April 2006 may offer a higher level of tax-free cash than the standard 25%. Great care is once again needed if a pension has this valuable benefit.
Another benefit that great care is needed with is the ability to take money out of a pension before the legal age of 55. This will increase to 57 in 2028, so plans that guarantee to be able to take money out at 55 will be valuable for certain people.
Potential exit charges
Some older pensions may apply exit charges if you transfer them. For those aged 55 or over, the FCA has introduced a cap of 1% on exit charges for most personal pensions, but those under 55 may face much higher charges.
In addition, plans investing into ‘with profits’ funds might include market value adjustments which are a transfer penalty in all but name.
Lack of diversification?
The report highlights that in putting all your pots in one place, you may be taking one investment approach with your money which might represent putting all your eggs in one basket. Another is the perception that there would be a lack of investor protection if you invested all your money into a SIPP.
As mentioned before, our investment approach is doing the simple things really well. We recommend portfolios that hold thousands of different companies across the world in cost-effective and simple funds. We do not complicate things for the sake of it, and this massively decreases the chances of having to worry about investor protections.
The report also mentions that having all your money in one pot might make it easier to react emotionally in the event of market sell-offs, as we saw earlier in the year. However, we find that when someone has a suitable and understandable strategy, they are more likely to follow it.