Pros and cons of consolidating your pension

Managing pensions has become increasingly complex in recent years, particularly for those who have held multiple jobs throughout their career. Since the introduction of automatic enrolment in 2012, millions of workers in the UK have been enrolled in workplace pensions. While this policy has significantly increased retirement savings, it has also created a common challenge: the accumulation of multiple small pension pots, often scattered across different schemes.

According to the Department for Work and Pensions (DWP), there are now 20 million deferred pension pots worth under £10,000, with 12 million valued at less than £1,000. This fragmentation can make it harder to track your pensions, potentially erode savings due to fees, and complicate retirement planning. Consolidating your pensions into a single pot may offer a solution, but is it always the right choice? Let’s explore the benefits, risks, and key considerations involved in pension consolidation.

The Benefits of Consolidating Your Pension

Cost savings are another compelling reason to consolidate. Each pension scheme typically has its own fees, which can include annual management charges, transaction costs, and other administrative expenses. For small pots, these fees can disproportionately impact your savings. By merging your pensions into a single, competitively priced scheme, you may be able to reduce these costs and preserve more of your money for the future.

Having a larger pension pot can also provide access to better investment options. Many workplace pensions offer limited investment choices, particularly for smaller balances. Consolidation can give you greater flexibility to align your investments with your risk tolerance and retirement objectives. Additionally, at retirement, a larger pot may allow you to secure better annuity rates or take advantage of more flexible drawdown options.

Perhaps most importantly, consolidation can potentially lead to better outcomes at retirement. 

The Financial Conduct Authority (FCA) has highlighted that more than half of small pension pots accessed at retirement are cashed out in full, often because they are too small to seem worth preserving.  By consolidating, you can create a single, more meaningful pot that may be easier to manage and more likely to be invested for long-term growth.

Potential Drawbacks and Risks

Despite the advantages, consolidating pensions is not always the best option. One of the most significant risks is the potential loss of valuable benefits associated with certain pension schemes. Some older pensions may offer features like guaranteed annuity rates, the ability to retire earlier than the standard age, or additional death benefits. Transferring out of such schemes could mean losing these perks permanently.

Fees associated with transferring pensions can also be a concern. While many schemes allow for free transfers, others may impose exit charges, which can reduce the value of your pot. It’s essential to understand the costs involved before making a decision.

The quality of the new scheme is another critical factor. Not all pension providers offer the same level of service, investment performance, or fee structures. Transferring your money into a scheme with higher charges or poorer investment returns could leave you worse off in the long run.

Finally, it’s important to consider the administrative and timing aspects of consolidation. While modern technology, such as the proposed pension dashboards has made it easier to track and manage pensions, the actual process of transferring funds between schemes can still take time and effort. Mistakes or delays in the transfer process could temporarily disrupt your pension savings.

Defined Benefit Schemes

Defined benefit, or final salary / career average pensions, are a very valuable asset for retirement, sometimes referred to as the gold-plated pension scheme. They provide a guaranteed income for life, which is often index linked so that your income payments can keep pace with inflation (up to certain limits) over your lifetime. 
Consolidating these types of pensions requires high quality regulated financial advice and it is only suitable in certain circumstances, due to the risks involved in sacrificing guaranteed income. Transferring away from such schemes means that you may then be exposed to investment volatility, as well as the risk that you may deplete your pension pot too early and run out of money to fund your retirement.

Key Considerations Before You Consolidate

When deciding whether to consolidate your pensions, it’s crucial to evaluate your personal circumstances and goals. Start by reviewing the details of your existing pensions. Look for any special features, such as guaranteed annuity rates, and assess the fees and charges associated with each scheme. This information will help you determine which pensions are worth consolidating and which might be better left untouched.

Next, carefully compare potential new pension providers. Look for schemes that offer competitive fees, strong investment performance, and a wide range of investment options. Keep in mind that the cheapest option isn’t always the best; value for money should be your primary consideration.

Your retirement goals should also play a key role in your decision-making process. Consider how consolidation fits into your broader financial plan. Are you looking to simplify your finances, reduce costs, or improve your investment options? Understanding your objectives will help guide your choice.

It’s also worth keeping an eye on upcoming developments in pension management. By 2026, pension schemes in the UK will be required to connect to pensions dashboards, allowing savers to view all their pensions in one place. This could make it easier to identify and consolidate small pots, but it also underscores the importance of ensuring that any transfers are made to high-quality schemes.

What to check before you combine your pensions

Before consolidating your pensions, it is important to ensure that you are not transferring away from a policy that is a ‘must hold’, and answering these simple questions about your existing scheme will help to establish whether it should be moved:

• With my current policy, can I access my pension benefits in a way that suits my objectives?
• Do the current death benefits work for me and my beneficiaries?
• Are there any guaranteed benefits that I should be aware of?
• What are the current charges on my pension, and are there any exit penalties that I should be aware of?

Final thoughts

Pension consolidation can offer significant benefits, including simplified management, cost savings, and improved retirement outcomes. However, it’s not without risks, and the decision to consolidate should be made carefully, based on a thorough evaluation of your existing pensions and a clear understanding of your retirement goals.

If you’re considering consolidating your pensions, take the time to research your options and seek professional advice where possible. A financial adviser can help you navigate the complexities of pension consolidation, ensure that you make the most of your savings, and create a solid foundation for a financially secure retirement.

The details in this article are for information only and do not constitute individual advice.

The Financial Conduct Authority (FCA) does not regulate tax advice.

Investment returns are not guaranteed, and you may get back less than you originally invested. Past performance is not a guide to future returns.

The information contained within this article is based on our understanding of legislation, whether proposed or in force, and market practice at the time of writing. Levels, bases and reliefs from taxation may be subject to change.