As part of what the Minister of State for Pensions, Steve Webb, has dubbed "Operation Big Fat Pension Pot", the DWP has launched the long-awaited consultation on proposals to deal with "the proliferation of small pension pots" (defined here as DC pension funds worth less than £2,000) in the workplace pensions system.

The headline-grabbing news from Webb's foreword to the consultation document is the announcement that the Government will abolish the use of short-service refunds* (SSRs) for defined contribution occupational schemes. In its response to the previous consultation, the Government has already ruled out abolishing SSRs from DB schemes.

* Allowable under FA 2004 (Sch 29 para 5), an SSR lump sum constitutes a refund of a member's contributions on leaving an occupational pension scheme before normal pension age and with less than two years pensionable service.

Availability of a refund is seen as a threat to the goals of auto-enrolment, as recipients will fail to build up a pension fund. The official Impact Assessment predicts this will retain an estimated £70-130m per year in pension saving (which might otherwise have gone to the high street - good for a stagnant economy?). The SSR rules will be abolished at the "earliest legislative opportunity", expected to be as soon as 2014.

The onset of auto-enrolment, current difficulties in the pension transfer system and high staff turnover are all expected to increase the number of small pension pots dramatically from around 1m currently to 4.7m by 2050. Small pots are potentially a problem to individuals: high management fees on dormant pots; difficulty buying an annuity; and losing track of entitlements. Additionally, small pots are a burden on pension schemes.

The condoc offers three alternative proposals to address this:

1. Improving the current member-initiated framework, including encouraging members to consolidate their pension savings and reducing the cost of administering small pension pots. This proposal would not overcome the problem of small pots being stranded due to individual inertia: it hasn't worked in Australia. There are other significant and well-known barriers to be overcome, including the complexity of the transfer process, the often-prohibitive cost of advice, and the unwillingness of many schemes to accept small transfer values.
   
   
2. Automatically transferring small pension pots to one or more aggregator schemes, so that all small pension pots are stored in one place. The aggregator would have to accept the very smallest pots; have low charges; a simple transfer-in process; and an appropriate investment approach. Persons falling out of pensionable service but remaining with the employer would not be default transferred.

   Aries comment
   
   With several alternatives crowding its nascent market, including NOW: Pensions from ATP, The People's Pension from B&CE and the BlueSky Pension Scheme from JIB, and a substantial taxpayer loan to be recovered, it will be no surprise if NEST is positioned as a strong candidate to be the main / only aggregator scheme.

3. Automatically transferring pension savings so they follow an individual from job to job. The individual's new scheme would initiate the transfer after active membership has been achieved. Where there are large gaps between employment, the pot would remain dormant in the old scheme. This is seen as the most ambitious proposal, requiring a central database. The Australian Government plans to introduce an auto-consolidation system where 'lost' pots will be transferred to a member's last active account, with the Tax Office directing the process.

Small personal pension pot commutation rules

Released today, HMRC's Pension Schemes Newsletter (PSN) 51 highlights a Treasury response to the problem of small personal pension pots (in addition to several other topical matters which we shall discuss in our next article). At the moment, there is no provision for scheme-specific commutation from a PP, in contrast to the rules governing occupational schemes.

PSN 51 flags up the draft Registered Pension Schemes (Authorised Payments) (Amendment) Regulations 2012, published on 6 December (see Aries article). The regs, which will amend the Registered Pension Schemes (Authorised Payments) Regulations 2009 (SI 2009/1171) allow individuals aged 60 or over, on or after 6 April 2012, with small personal pension pots of £2,000 or less to commute a maximum of two such pots in a lifetime. The payment must extinguish the member's entitlement to benefits under the arrangement.

As the regs are to apply at arrangement rather than scheme level, payments can be made from two separate registered pension schemes or from the same scheme where the payments are under different arrangements in that scheme. Additionally, because these small lump sum payments do not have to extinguish all entitlements under the entire scheme, they are not classed as a trivial commutation lump sum under FA 2004 (Sch 29 para 7(1)).

Indeed, the intention is that these small lump sum payments can be made in addition to a trivial commutation lump sum and regardless of the individual's total pension savings.