Bigger Is Not Always Best For Pension Savers
The new pensions dashboard may encourage retirement savers to tidy their finances by consolidating pensions – but this is not always a good idea, says one expert.
Former Pensions Minister Steve Webb, who is now a director at financial firm Royal London, reckons savers should take professional advice before consolidating as the wrong decision could make them worse rather than better off.
Webb says there are five good reasons not to consolidate pension pots – which means to switch them all into one bigger retirement fund.
The biggest pitfall is transferring the money only to find you have forgotten to check if the scheme offers enhanced tax free cash, early retirement options or other benefits.
Small pot privileges
Some pensions started before April 6, 2006 – the date when the modern pensions regime started – carry these and more extra benefits.
They can also come with guaranteed annuity rates that off a promise to pay an income for life in retirement that far exceeds the amount an annuity offers at current market rates. If the money is transferred out to a new scheme, this benefit is lost.
Carry out a cost/benefit analysis of moving pension money. The pot may earn more in another wrapper, but the exit charges attached to leaving the current scheme may dilute any profits that come with the new one.
If the pots for consolidation are small – which generally means less than £10,000 each – pension rules allow grouping three together without including the £30,000 total as part of the lifetime allowance (LTA).
The LTA is fixed at £1.055 million and is the maximum amount anyone can save in pensions during their lifetime. The small pot privileges extend this allowance to £1.085 million.
Little-known pension hack
Another little known pension hack for small pots is avoiding the money purchase annual allowance (MPAA) trigger. Withdrawing cash from a large pot sets off the MPAA, which reduces the annual £40,000 pension contribution limit to £4,000, but taking a small pot is exempt from this rule.
“One of the questions I am asked more often than any other is whether people should combine all of their pensions in one place,” said Webb.
“While that may seem the tidiest thing to do and can have some advantages, there are also a number of unexpected disadvantages to merging pension pots. Older pension policies may have attractive features which would be lost if transferred, whilst small pots benefit from certain tax privileges which do not apply to larger pots. As ever, the best approach is to talk to seek impartial advice or guidance before consolidating pension pots.”