Seven questions to ask before consolidating pensions

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.

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 AJ Bell’s pension-finder tool to track them down and then bring them together in one place.

However, before you make the move, you need to be aware of the potential pitfalls. These are seven questions to ask to make sure that consolidation brings you all the potential benefits, without making any expensive mistakes.

Seven questions to ask

1. What kind of pension am I considering moving?

Very broadly they come in two flavours, defined contribution and defined benefit. Most modern pensions outside the public sector are defined contribution, where you – and your employer if it’s a workplace pension – pay in a fixed sum each month. That will be invested and grow, and you will come to retirement with a pension pot. It will then be up to you how you draw an income from it. The income you get depends on how much you pay in, how much it grows, and how you draw that income. If you use an annuity you’ll get a fixed income for life, but it may not be as generous as if you use income drawdown. If you use drawdown and take too much, there’s a risk the money runs out during your lifetime.

Defined benefit pensions, meanwhile, are either final salary schemes or career average schemes, and offer you a fixed income for life that’s linked to your salary. Each year you work for the company offering this pension, you earn a proportion of this salary. So, for example, your pension may offer 1/60th of salary a year. It means someone with a final salary of £60,000 would earn an annual pension of £1,000 – which is 1/60th of their final salary, for each year they worked. If they worked for 30 years, they would have a pension of £30,000 a year in retirement. You’ll pay in a fixed sum, but the outcome won’t depend on investment performance. There’s no risk of running out of income, because it’s guaranteed for life.

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.

2. Do I want to take advantage of small pot rules on any pensions?

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, rising to 57 on 6 April 2028). 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.

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3. What are the charges in my current pensions?

Older pension schemes often charge more than modern pensions. While a charge cap of 0.75% applies to the default investment option in auto-enrolment workplace pensions today, many pension policies, including older contracts or those set up outside auto-enrolment, may carry higher fees.

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 (see table below).

4. What charges will I pay to leave?

Pensions opened since 2017 don’t have any exit penalties, but some older pensions do. In some kinds of pensions, they are capped at 1% for those aged 55 and over, and the fees are banned if you’re over the normal scheme retirement age. However, if you’re in an older scheme you could be charged.

Often this is through what’s known as a market value reduction. These reflect the difference between the guaranteed value you see on your statements and the value of the underlying investments. The difference will depend on performance, but in difficult markets can be as much as 15%. It means you’d need to calculate whether the difference in the ongoing charges will make up for this over the time you have left in the pension.

You should be able to find details of any exit penalties in the paperwork you got at the outset or any statements you have received. If you don’t have any of these things, or there’s a market value reduction, you can get in touch with the pension company directly for details.

5. Is there a guaranteed annuity rate?

In some older pension schemes, the provider guaranteed a particular annuity rate at retirement. If you hang onto the pension and choose to take the annuity offered by the provider, they will guarantee a percentage return for life. These were often set between 7% and 11%. This is way above current rates, and this is likely to remain the case any time inflation and interest rates are under control. If you switch away, you lose the guarantees, which means in many cases it’s worth hanging onto these pensions.

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6. Is there a protected lump sum?

Within some older pensions, the provider offered more than 25% tax-free cash. All modern schemes are limited to 25%, so if you switch away you will typically lose this, unless you can find someone else to transfer with as a part of a ‘block transfer’ (sometimes called a ‘buddy transfer’). If you’re unable to find someone to transfer with, as will likely be the case, and you’re planning to take all the available tax-free cash, you may well choose to hang onto these pensions rather than transfer them.

7. What pension should I move to?

Before you move, consider what you want from your new provider. You may want plenty of investment choice and a provider who offers a ready-made option for those who are getting to grips with investments. A Self-invested personal pension (SIPP) from an investment platform is likely to offer far more choice than a traditional pension provider.

You are likely to want plenty of information and support. You will also want to weigh up the charges, and whether they offer value for money. You’re likely to be moving partly in order to cut the charges, so don’t undo all your good work by opting for a more expensive provider.