How to solve the small pension pot dilemma

How many jobs have you had during your working life?  Research from LV= found that the typical person will have around nine different jobs, changing employers, on average, once every five years.

But while changing jobs can be a great way to boost your earnings, or improve your work/life balance, it doesn’t make your retirement planning any easier. Regularly switching jobs can mean you end up with a veritable collection of pensions, some of which could be pretty small, particularly if you didn’t stay with that employer for long.

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These pots may not cause you any bother during your working life. Even if you – and your former employers - are no longer paying into them, they’ll remain invested and will keep ploughing on until you tell them to do otherwise.

However, as retirement edges closer, it becomes increasingly important to switch on to all your pensions (not just the one you are paying into) and start thinking about how you might incorporate them into your overall investment strategy.

Make sure you know where all your pensions are

The first step is to make sure you know exactly how many pensions you have and that you have paperwork or log-in details for each. Go back through your career and try and match a pension to each job. Following the introduction of auto-enrolment – which was phased in between 2012 and 2018 – you should have a pension per job (so long as you met the eligibility criteria). Prior to that, whether you had a pension or not, will depend on whether a workplace pension was available and if so, whether you joined it.

It's easy to lose track of pensions over the years, especially when you move home and don’t update all your providers with your new address. If you think you might have had a scheme or two go AWOL, it’s worth doing a bit of digging. Contacting former colleagues or HR departments can help. Alternatively, you can try the government’s free pension tracing service – you just need the names and addresses of your former employers and your national insurance number to get started.

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According to the latest data from the Pensions Policy Institute, there are currently 3.3 million “lost” pensions, worth an average of £9,470 each.

Think about consolidation

Having lots of smaller pensions will ultimately make your retirement planning a bit fiddly – it will be harder to get a view of how much you have saved and whether your income goals are on track. It will also mean you’ve got multiple pension providers to deal with, which could cause something of an administration headache.

For this reason, it may make sense to consolidate all the pensions that you are no longer contributing to, into a new personal pension, such as a self-invested personal pension (SIPP). So long as you are happy to decide where your retirement savings are invested, combining multiple pensions into one pot will simplify your planning. 

You might also find that this lowers the cost of saving for retirement. Modern, online SIPPs may have lower charges than older workplace pension schemes, especially those you are no longer paying into.

If you are leaving a more “old-fashioned” scheme, you might also find that a new SIPP will give you access to the full range of retirement income options, including flexi-access drawdown, which may not be available with older pensions. In addition to extra flexibility, you’ll also get more control over your pot and access to a much wider range of investments.

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A SIPP won’t offer a default or lifestyle fund like workplace pensions (which take all the decision-making out of the process). However, a good SIPP provider can offer guidance on low-cost investment solutions for investors who want to keep things simple.

Before you transfer any pensions, it’s important to check whether you’ll lose out on any valuable benefits, such as guaranteed annuity rates. You also need to look out for exit fees on pensions that were taken out before 31 March 2017. These are capped at 1% once you are over 55 but may be higher if you are younger.

It usually makes sense to keep your current workplace pension open, unless you can convince your current employer to pay its contributions into your SIPP (which it may, or may not be willing to do).

Understand the small pot rules

When you are reviewing your pensions, it’s also important to understand that if you have any defined contribution (DC) pensions that are worth £10,000 or less, they will be subject to “small pot” rules.

Depending on your situation, you may be able to take advantage of these to add a bit more flexibility to your planning as you approach or enter retirement.

Once you have reached the age of 55 (rising to 57 in 2028), it’s possible to cash in your small pots without triggering the money purchase annual allowance (MPAA) which reduces the amount of money you can pay into your pension and still get tax relief to just £10,000 a year.

This means that if you want (or need) to take a lump sum out of your pension, while you are still working and paying into it, it makes more sense to cash in small pots before you raid larger ones. This will preserve your allowance and mean you can carry on paying 100% of your income, up to £60,000 a year into your pension.

When you cash in a small pot, you can still take 25% tax-free, with income tax being charged on the remainder at your marginal rate.

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You can cash in three personal pensions in this way (up to a maximum of £30,000) but there’s no limit to the number of occupational schemes that can be accessed in this way, so long as each individual pot is worth less than £10,000.

You may also be able to cash in smaller defined benefit (DB) pensions too, using the trivial commutation rules. However, to qualify for this, the value of all your pension benefits (including other money purchase schemes) must be below £30,000.

Small pot payments will also not use any of your lump sum allowance (LSA) and lump sum death benefit allowance (LSDBA) – two allowances that were introduced to limit the tax-free benefits that can be taken from a pension in the wake of the abolition of the lifetime allowance (LTA) in April 2024.

However, while you can cash these pots, it’s important not to cash them in simply because you think they are too small or fiddly to deal with. You could still end up paying a considerable amount of tax on them – especially if the withdrawal bumps you into a higher-rate tax bracket.

When considered alongside your other pensions, they could still give your retirement finances a considerable boost.

Is the government doing anything to help?

Auto enrolment has been a great success, in terms of the impact it has had on the number of people who are now saving for retirement.

However, the downside is that it means that there are only going to be more people juggling small pots.

This is very much on the political radar. Successive governments have been working on the “pensions dashboard” over the past decade which should allow people to view all their pensions in one place, while the recent Conservative government explored opportunities around the “pot for life”. This would involve workers, rather than employers, choosing their own pension. Employers would then pay into that pot, which would move with the worker from job to job. But while that might simplify pension savings for workers, there were concerns that the scheme might be difficult to implement from an employer point of view.

While it’s looking like the Labour government has dropped that particular model, it is looking at pensions consolidation as part of its Pension Schemes Bill – including the automatic consolidation of pots worth less than £1,000.

However, to date, progress has been slow (pension dashboards are unlikely to go live until 2027), so in the meantime the problem of dealing with small pots very much comes down to individuals.