Pros and cons of consolidating multiple pension pots

Andrew King. Croner.

Changes to inheritance tax liability mean unused pension pots will be taxed from 2027 so the question is does it make sense to restructure assets? Andrew King, pensions technical specialist at Evelyn Partners, explains.

From April 2027, unused money-purchase pension assets will be included in estates for the calculation of inheritance tax (IHT) and this is already having consequences.

Many pension savers are deciding to take their tax-free lump sum or draw down more heavily on their pension pots in order to spend or gift, or in some cases buy annuities, so that they are not leaving a surplus pot that will be taxed at 40% at death. And potentially face double-tax if someone dies at age 75 or over, as a beneficiary may also pay income tax on the inherited pension fund at their marginal rate.

Another step in preparing for this major change could prove wise, due to the IHT and probate rules around the administration of estates that include pensions.

It is evidently sensible in most cases to have pension savings in one place. Managing multiple pots is risky and time consuming: it requires effort to keep track of them all, and pots can be forgotten, with hard earned savings effectively lost.

Even for those who keep good records, it’s a plate spinning exercise to manage investment choices, assess risk, gauge performance and work out what income total savings might provide at retirement.

Having a clear picture of overall pension funding is especially important as retirement nears – but ideally much earlier, while there is still time to act.

Older legacy schemes can charge higher fees, impose exit penalties and restrict some of the flexible options and death benefits introduced with the 2015 pension freedoms, for example by not offering flexible drawdown. In these cases, consolidation can bring clear benefits, as can access to a wider choice of investment funds.

That said, the opposite can also be true for some savers, who may be better off keeping one or more legacy or deferred schemes. In short, it is not essential to have a single pot, but it is far easier to take control of retirement savings if they are not spread all over the place.

Ideally, today’s workers would not accumulate large numbers of small defined contribution (DC) pots in the first place. Younger and middle aged employees who have benefitted from auto enrolment but are building up multiple pots should consider rolling them up as they go along – either into their current workplace scheme or into a personal pension such as a self-invested personal pension (SIPP).

Having fewer pots makes it easier to monitor investments and performance, which in turn gives greater clarity over the size of the pot at retirement and the income it might generate. However, there are variables and complexities, so holders of multiple schemes should look carefully at their savings before embarking on a DIY consolidation.

DIY pension consolidation

If you plan to go it alone, these are key points to consider:

• Defined benefit schemes or plans with ‘safeguarded benefits’ are highly likely to be better left alone. In any case, defined benefit (final salary) pensions worth more than £30,000 cannot be transferred without advice.

• Most modern DC workplace pensions can be consolidated into a current workplace scheme, or a personal pension such as a SIPP.

• In most cases, it makes sense to remain in your active workplace scheme, where employer contributions continue, even if deferred pots are consolidated elsewhere.

Which pots are worth keeping?

Deferred defined benefit (DB), or final salary, schemes that offer a guaranteed income for life and remove investment risk are usually worth retaining. That is even more the case now than in recent years, as relatively high interest rates and bond yields have reduced transfer values, meaning members are typically offered far less to leave these schemes than they were a few years ago. Even so, if the value exceeds £30,000, regulated financial advice is mandatory.

Those with smaller DB pensions may feel the income offered is not worth keeping, but caution is needed. A guaranteed, index linked income to supplement the state pension is something many people pay dearly for via annuities, and there may also be valuable spousal benefits.

Circumstances can change if a transfer offer is clearly favourable, or if ill health and limited life expectancy make a guaranteed income less appealing, particularly close to retirement.

It is not only final salary pensions that require caution.

Some DC schemes include ‘safeguarded benefits’ such as guaranteed annuity rates, protected tax free cash or spousal benefits. Savers should think carefully before giving these up, and advice may be helpful to understand their value. Similarly, some older schemes impose exit penalties, making it preferable simply to hold on to them.

How to consolidate

Employees have two main options: rolling deferred pots into their current workplace scheme, or consolidating them into a personal pension such as a SIPP.

This is largely down to preference. Many – particularly younger workers – may find it simplest to roll DC pensions into each new employer scheme, provided they are happy with the fund range and fees.

Larger workplace pension providers now offer transfer services that are quite quick and straightforward, though you will need to supply details such as policy and National Insurance numbers.

SIPPs tend to suit those who want a broader investment choice and a more hands on approach. While SIPPs carry an account charge, these have fallen, and such accounts can make ad hoc, lump-sum contributions easier than a workplace scheme. They may also offer greater flexibility when accessing funds.

Even where a SIPP is used to consolidate old pots, it usually makes sense to remain in the current workplace scheme to benefit from employer contributions and salary sacrifice. Net pay arrangements also ensure all tax relief is applied automatically, avoiding the need for higher rate taxpayers to reclaim it.

Taking control of your pensions with advice

The stereotype is that financial planning is only for the wealthy, but many savers who assume it is not for them could benefit from advice, not least because it improves retirement outcomes.

Many simply lack the time, confidence or motivation to manage pensions themselves. Advice can still add value for those with modest savings, particularly where plans are complex or legacy pots are poorly understood.

The closer someone is to retirement or taking benefits, the higher the stakes become around consolidation and transfer decisions – and the more valuable advice tends to be.

A financial planner can identify which pensions to keep, whether consolidation makes sense, how to move into drawdown and whether investments remain appropriate.

Crucially, they can also place pension savings in the context of someone’s wider financial position, factoring in other assets and income. Most people underestimate what they will need, and advice can at least open their eyes to that reality.

Evelyn Partners can provide both routes to consolidation. The DIY option is available through its consumer-facing digital investment platform Bestinvest, which offers SIPP options, while financial planning clients will have the process managed under advice, which can be accompanied by investment management services where necessary.

About the author

Andrew King, pensions technical specialist at Evelyn Partners