UK pensions: defined contribution (DC) consolidation

Measures announced or confirmed alongside the Autumn Statement to promote DC consolidation include:

• Value for Money Framework
• DWP Master Trusts Review
• Requiring DC schemes to provide decumulation services
• Raising expectations of trustees: trustee register and trustee knowledge and understanding
• Ending the proliferation of small deferred pots
• Introducing a “lifetime provider” model

Value for money framework 

The belief that value for money in DC arrangements consists of more than simply low charges is fundamental to the government’s plan to boost investment in productive finance while improving outcomes for members.

The DWP, the Pensions Regulator (TPR) and the Financial Conduct Authority (FCA) intend to develop a “holistic framework” on value for money, which can be applied consistently across the whole DC market.  The FCA plans to consult in spring 2024 on draft rules for contract-based schemes.  For occupational trust-based schemes, legislation will be required – this may take some time, so in the meantime trustees will be encouraged to engage with the FCA consultation.

The administrative burden to be imposed by this new framework will add to the pressure on some occupational scheme trustees (and the employers who fund them) to exit direct pension provision by consolidation into a commercially provided scheme.  In practice, this will often mean a transfer into an authorised DC master trust.

DWP review of master trusts

The government sees authorised master trusts as “integral to our pensions system” and key to promoting consolidation of smaller schemes.  The DWP expects that master trusts could triple their assets under management in real terms by the end of this decade – which, of course, the government hopes will lead to significant investment in productive finance.

Alongside the Autumn Statement, the DWP published a review of the master trust authorisation and supervisory regime.  A key outcome is that the Pensions Regulator (TPR) is expected to shift its regulatory focus from preventing disorderly scheme failure to a greater emphasis on investment governance and value.  TPR has confirmed that it will challenge master trusts on investment decisions and will focus on value received by members.

Providing DC decumulation options 

In a response to consultation on supporting DC members at the point of retirement, the DWP reports that only 29% of 55-59 year-olds said they had a clear plan and 17% did not know they had to make a choice.  Clearly, not all retirees are embracing the responsibility placed on members by the “freedom and choice” reforms of 2016. 

To address this, trustees will be required to offer decumulation services which are suitable for their members and consistent with pension freedoms.  The decumulation routes provided must include a default option for those who do not wish to make a positive choice.

Decumulation options may be provided direct by the occupational scheme, or through arrangements with a commercial provider.  The DWP intends to monitor the potential for decumulation to be provided through new style collective defined contribution (CDC) arrangements.

Legislation will be needed to impose the new trustee duty.  As for now, trustees are encouraged to offer decumulation options on a voluntary basis.  The Pensions Regulator (TPR) is expected to issue interim guidance, to apply before new legislation is in place.

Many single employer (or single corporate group) DC schemes do not currently cater for a range of decumulation options, and may simply require members to transfer out at retirement or individually annuitise.  For some DC trustees, having to select and offer decumulation choices will be a significant additional responsibility – and may further increase the attraction of total outsourcing to an authorised DC master trust or other commercial provider.

Trustee skills and registration 

The DWP has issued the outcome to its call for evidence in July 2023 on trustee skills, capability and culture.  The majority of trustees were found to be well-supported, knowledgeable and hard-working.  However, the DWP concludes that “it is clear there is space for action to ensure that all trustees are able to work effectively”.

A key outcome is that trustees will be required to register with the Pensions Regulator (TPR).  The intention is that a register will help TPR both to improve communication of information and guidance to trustees, and to collect information from trustees to assess whether trustee knowledge and understanding (TKU) requirements are being met.  No timescale is given but the DWP states that it “will continue to work with TPR to develop and take forward this proposal and determine next steps”.

In addition, the DWP strongly encourages professional trustees to seek accreditation with the Pensions Management Institute (PMI) or the Association of Professional Trustees (APPT), and is reviewing whether this should be made a statutory requirement.  The response comments that TPR’s General Code (when it is finally issued) will expect professional trustees to be accredited.

As part and parcel of encouraging investment in productive finance, TPR is to update its investment guidance (we were told by the end of 2023) and will expand its TKU syllabus to cover alternative investments.

DC consolidation: small pots 

The government has decided to adopt a “multiple default consolidator” (MDC) approach, with a central clearing house, to tackle the growing issue of the proliferation of small DC pension pots.

When the system is up and running, deferred DC pots which meet certain eligibility criteria will be transferred automatically to a consolidator scheme, unless the member makes an active choice.

Which pots will be automatically consolidated? 

Only “eligible” pots will be transferred under the MDC model.  A pot will be “eligible” if:

• It was created since the introduction of auto-enrolment;
• It is held within an auto-enrolment charge-capped default fund;
• No active contributions have been paid for at least 12 months; and
• The value of the pot is less than £1,000.

In time, the definition of an eligible pot may be widened. 

How will pots be allocated? 

If the member does not actively choose a consolidator, then:

• Where the member already has a pension pot with an authorised consolidator, any further eligible pots will be allocated to the existing pot with that consolidator;
• If the member has multiple pre-existing pots, any further eligible pots will be allocated to the consolidator with the largest pot; and
• If there is no pre-existing pot, the member’s pot will be allocated to one of the authorised consolidators using a “carousel” approach – that is, pots will be divided among authorised consolidators in equal proportions.

How will pre-existing pots be matched? 

A central clearing house will be established to:

• Match eligible deferred pots with any pre-existing pots for the member and, otherwise, to allocate eligible pots to a consolidator; and
• Lead on communications with members and schemes.

The central clearing house could potentially have a role in the future development of a lifetime provider model (please see below). 

Which schemes may become consolidators? 

Pension schemes wishing to act as consolidators will need to be authorised by either the Pensions Regulator (TPR) (for occupational schemes, including master trusts) or the Financial Conduct Authority (FCA) (for contract-based providers). 

Authorised consolidators will need to meet certain requirements, likely to include: auto-enrolment minimum standards; already offering same scheme consolidation (where an individual has more than one pot within the same scheme); demonstrating good Value for Money; and providing a default decumulation offering. 

What are the next steps? 

An industry delivery group will be established early in 2024, to work through some of the practical and detailed policy issues which will arise when introducing the MDC system.  The group’s work is likely to be informed by lessons already learned in relation to pension dashboards.  

Legislation will be needed to establish the new system – as with several other pension reforms, this will be brought in “when Parliamentary time allows”.

Taking consolidation further: the "lifetime provider" model 

The government’s ambitions for DC pension scheme consolidation do not stop at the small pots “multiple default consolidator” (MDC) model.  At the same time as confirming the intention to adopt MDC, the DWP issued a call for evidence on a lifetime provider model – which would go far further than simply sweeping up small deferred DC pots.

What's the difference between small pot MDC and the lifetime provider model? 

The proposed MDC arrangements will do nothing to prevent a new pot with a different provider being created every time an individual starts a new job.  What MDC will do is ensure that if a pot is worth less than £1,000 and does not receive contributions for a year, it will be transferred to an account with an authorised consolidator – and that any subsequent small deferred pots belonging to that member are transferred to the same consolidator.

In contrast, the lifetime provider model would prevent multiple pots for a single person arising in the first place – by requiring the individual’s employer(s) to contribute to the employee’s “lifetime” pot, instead of to the employer’s chosen pension arrangement.

How could a lifetime provider model work? 

The DWP has been heavily influenced by the Australian system of “stapling”, under which employers must check if a new employee has an existing superannuation fund before paying pension contributions.  A new pension pot may only be created where either:

• The employee makes no choice of fund and the Australian Tax Office confirms that no stapled fund exists for the employee; or
• The employee actively chooses the employer’s default fund.

How will an employer know about an employee's existing pension? 

The call for evidence suggests that some form of central architecture could be put in place to allow an employer to identify an employee’s existing pension arrangement, without any pension information needed from the employee. 

Potential impact on payroll systems

Advocates of the lifetime provider model point out that employers already pay employees’ wages to accounts held with a multitude of different banks – and argue that contributing to pension pots held with different providers should be little different.  This seems possible in theory, but in practice would likely require significant development of payment systems on both the employer and pension provider sides.

A further technical complication is that there are currently two different ways in which tax relief is obtained on member contributions – those paid to occupational pension schemes are usually made from pre-tax income under a “net pay” arrangement; whereas member contributions to personal pensions are paid out of taxed income, with the provider claiming basic rate tax relief under “relief at source” and the member using self-assessment to claim any higher rate tax relief due.  Under the lifetime provider model, will an employer’s payroll system have to operate both net pay and relief at source, depending on the type of each employee’s pension?  If so, two employees with identical pay and pension contribution rates may receive payslips showing different amounts deducted for income tax and pension contributions, if one individual is a member of an occupational scheme using net pay and the other has chosen a personal pension. 

What are potential advantages of a lifetime provider model? 

The lifetime provider model could mean that an individual joining the workforce with no previous pension history will build up only one pension pot in their lifetime.  This may lead to greater ownership and engagement with pension saving, as well as resulting in fewer transfers between schemes.

The DWP considers the model may also encourage investment in illiquid productive finance.

What are potential impacts on pension providers? 

Commercial providers which provide a pension arrangement for all (or the majority of) an employer’s employees benefit from larger scale and relatively stable contribution inflows.  Although contributions in respect of lower-paid staff will be individually small, the provider may be able to offer more favourable charges or other conditions for an employer’s arrangement than would be commercially viable for a retail customer. 

Some commercial providers, including authorised master trusts, do not currently offer pensions to the retail market.  It is not clear from the call for evidence whether a master trust (or other workplace pension provider) will be forced to accept pension contributions in respect of an employer’s former staff who move to new employers, while retaining the master trust account as their lifetime pot. 

Clearly, accepting contributions from hundreds or thousands of different employers each in respect of, potentially, only one member would raise significant issues for scheme and employer administration.  

Members: what are the potential impacts? 

Currently, employees in auto-enrolment default funds benefit from the charges cap and requirement that the funds be invested in the best interests of members.  Both these requirements give a degree of protection to members. 

The risk must be that an individual is persuaded to take out a pension arrangement that may not be (or remain) in that person’s best interests.  Nevertheless, unless the individual actively chooses another scheme, all subsequent pension contributions will automatically be paid to their first scheme throughout their working life.  Employers cannot be expected to supervise every pension scheme which their employees belong to (in the same way that employers are not responsible for employees’ choices of bank accounts to receive their pay). 

Employers: what consequences might the lifetime provider model bring? 

Somewhat ominously for employers who currently invest significant resource in providing a valuable (and often employer-branded) pension arrangement for their employees, the call for evidence claims that:

“there is a case for changing the relationship between the employer and employee, ensuring that employers are still required to contribute to a pension for their employee, but redesigning the system so that employees have more agency and control over their own pension”.

The call for evidence does recognise that exemptions may be needed where an employer provides defined benefit (DB) benefits, collective defined contribution (CDC) benefits, or DC arrangements with more generous features such as significantly higher employer contributions.  It also recognises the need to consider whether introducing the lifetime provider model would reduce employers’ active involvement in their employees’ pension saving.

Authored by the Pension Team.