An expert has issued a warning for anyone who earns more than £10,000 and said people need to watch out for being left 'worse off'. Rules on auto-enrolment now mean that anyone who earns more than £10,000 and is aged over 22, born before 2004, should be in a pensions scheme when they start a new job.
However, if people change work they may end up in many pension schemes and be considering consolidating them together. Sarah Coles, head of personal finance at AJ Bell, said there are benefits because consolidating pensions can allow the person to switch away from expensive schemes with fewer investment choices, keep track of savings and make more informed decisions at retirement.
Benefits of combining pensions
Coles said: "Most people are currently collecting pensions like they're trying to complete some sort of set. The automatic-enrolment rules mean that as long as you're aged 22 or over and earning at least £10,000 a year, you'll be automatically enrolled into the pension when you start a new job. When you leave and start somewhere else, you'll leave the pension behind and begin a whole new one. It means you can easily pick up pensions in double-digits during a working life."
She added: "Combining your pensions with a single provider can make a lot of sense. It's easier to track and manage than having several pensions with different providers, so you're less likely to lose them when you move house or change email address.
"It can help you make more joined-up decisions about taking income in retirement. You're more likely to just cash in a small pot because it doesn't seem worth converting it into an income, whereas combined with other pensions it could make a vital difference to the income you can afford to draw. You could also benefit from lower costs and charges, increased income flexibility and more investment choice by switching provider. If you're not sure how many pensions you have, or where they are, you can use free pension finder tools to track them down and then bring them together in one place."
Pitfalls and key questions
However, there are some pitfalls that could leave the person worse off if they fall foul of them. Coles said: "However, before you make the move, you need to be aware of the potential pitfalls, so you can protect yourself against them. There are seven questions to ask to make sure that consolidation brings you all the potential benefits, without making any expensive mistakes."
She said there are two types - defined contribution and defined benefit - with most outside the public sector the latter. She said: "If you're considering a switch from a defined contribution pension into another defined contribution pension, you're comparing like-with-like, so it's easier to weigh up the costs and benefits. If you're thinking about a switch from defined benefit to defined contribution, you're comparing very different beasts, and you're giving up incredibly valuable guarantees that would be far more expensive to replicate through a defined contribution scheme and an annuity. It's why in the vast majority of cases it's not worth making this switch."
Small pot rules and charges
For small pots - which is anything under £10,000 - people can take advantage of rules. She said: "If a defined contribution pension is worth less than £10,000, it falls under what's known as the small pot rules. It means you can withdraw it all at any time after you reach the minimum pension age (currently 55). 25% of it will be tax-free and 75% taxed as income. You can do this for up to three personal pensions and any number of workplace pensions.
"The key rule difference is that normally if you take more than the tax-free cash from a pension, you will trigger what's known as the money purchase annual allowance. This limits how much you can pay into a pension each year to £10,000. The idea is to avoid people withdrawing money from one pension and then recycling it into a new pension for another round of tax relief, but even if you have no intention of recycling it, you can fall foul of the rules.
"If withdrawing smaller pots in full works for your retirement plans, you may want to keep them in place. However, you need to weigh this up against the tax you'll pay when you withdraw them, and ongoing charges between now and retirement, which can easily erode a small pot."
She said older pensions schemes tend to charge more than modern ones which could be an opportunity to change it to save money. She said: "The impact of reducing your pension charges can be significant, particularly over the long term. Someone combining three pensions with charges of 1.5% to 0.75% could boost their pension pot by over £7,000 over 10 years or £20,000 over 20 years if they were to switch to a single, lower cost account."
