Techzone

Why consolidate?

Pension consolidation simply means bringing multiple pension pots together into a single pot. This can bring wide ranging benefits at all stages:

• While saving – it can cut costs, simplify monitoring against retirement goals and help with asset allocation.
• At retirement – it can provide access to flexible benefit options and help holistic multi-wrapper tax planning.
• On death – it can give access to all death benefit options and help maximise wealth transfer to family and friends.

This practical guide focuses mainly on the considerations for individuals with benefits in defined contribution schemes. 

There are additional considerations for clients with defined benefit schemes. More details on these transfers are contained in our technical guide 'Pension transfers - DB to DC'.

Don't lose touch

Workers now average 11 jobs* during their working lives, so it’s not uncommon to have built up pensions across several pension schemes. It can be easy to lose track of pensions which have been built up with previous employers. The government's pension tracing service can help track down previous workplace and personal pensions for those who have lost details of their pensions. 

Consolidating pensions from previous employments into a single scheme avoids the problem of losing touch with pension savings.

* Source: https://www.gov.uk/government/news/new-pension-tracing-service-website-launched

Retirement and death benefits options

The ‘pension freedoms’ introduced in 2015 undeniably sparked a demand for transfers to modern contracts which can provide all the retirement and death benefit options. The option of income drawdown can give the member and their beneficiaries greater flexibility and tax efficiency in how they take the pension savings.

The introduction of the ‘lump sum death benefits allowance’ (LSDAB) following the removal of the lifetime allowance on 6 April 2024 further strengthens the case for being in the right scheme.

As the name suggests, the LSDBA only applies to lump sum payments. On death before age 75, lump sum death benefits paid in excess of the available LSDBA are subject to income tax at the beneficiary’s marginal rate. However, any death benefits paid as a pension are not tested. So, on death before age 75, beneficiaries who choose beneficiary's drawdown can draw as much as they want, when they want, tax free.

Many schemes have a minimum fund size before a member can use income drawdown, so consolidation can help remove that barrier. And being in a scheme with all the options still gives the member the option of choosing an annuity if that best suits their needs - income drawdown won’t be right for everyone.

Passing on accumulated pension wealth is much easier if everything is held within a modern pension scheme which has the full range of death benefit options.

The option of beneficiary's drawdown can allow family or friends to keep the remaining pension fund invested within the pension wrapper. This means they could continue to enjoy tax-free investment growth, keep the pension fund outside their estate, while still having access to the funds at any time.

But if funds are left in a scheme which doesn’t offer beneficiary's drawdown, the client’s loved ones may only have the options of a lump sum or an annuity.

Consolidation makes it easier for the client's death benefit instruction to be kept up to date, as there will be only one nomination to review.

Monitoring against goals

Having just one large pension pot rather than lots of smaller pots helps clients to keep track of their retirement goals. It cuts down the number of valuations needed and makes getting projections far simpler. 

Reduce costs

There will be a cost for receiving advice on consolidating pensions, but clients could get better returns if transferring from higher cost schemes to a lower cost one. Investment choice is another obvious consideration. The negative effect of high charges and poor fund performance shouldn’t be underestimated. So investment choice and the associated charges under a client’s existing schemes should be reviewed.   

Some schemes have tiered charges - the larger the fund, the lower the charges - so consolidation can help reduce some charges and potentially help achieve greater returns.

Asset allocation

Getting the investment strategy right can play a huge part in achieving retirement goals for clients with defined contribution pension schemes. The clients' risk profile will determine the required asset mix. But this becomes increasingly difficult to arrange and monitor where there are multiple pension pots, possible default funds or where there’s a limited selection of funds to choose from. With everything together in one place, it becomes easier to get the asset allocation right and keep it right.

Things to watch out for

Consolidating pensions can have many benefits, but it’s important to make sure that any down sides are carefully considered too. There are several potential pitfalls to watch out for.

That’s not to say that the transfer shouldn’t still go ahead if there is an issue; what’s important is that the decision to transfer, or not, leads to the outcome that best meets the client’s needs and goals.

The following are some of the more common things to watch out for – but it’s not an exhaustive list.

Transfers in ill-health - IHT

HMRC take the view that transferring pension benefits from one scheme to another is a transfer of value for IHT. This is regardless of whether the pension benefits in both the original and the new scheme are outside the estate for IHT.

This will only potentially be an issue if the client was in poor health at the time of transfer. A Court of Appeal decision in the ‘Staveley Case’ has called into question HMRCs approach to transfers in ill-health.

HMRC haven’t updated their guidance following the decision which leaves an amount of uncertainty on the IHT position on transfers where a clients suspect they may not survive for more than two years from the date of transfer.

To avoid this uncertainty, it makes sense for any client considering a pension transfer to act before their health starts to decline.

More details on pension transfers and IHT is contained in our technical guide 'Pensions and IHT'.

Guarantees or other benefits

Particularly with older schemes, care is needed to check if any valuable investment or annuity rate guarantees could be lost. For example:

• Guaranteed annuity rates can result in a significantly higher retirement income. However, these sometimes apply only at a certain age.
• With-profit funds could have investment guarantees or a potential terminal bonus. Watch out also for the possibility of a market value adjustment (MVA) or other exit penalties on transfer.

Workplace schemes

Clients looking to transfer benefits from their employer’s pension workplace scheme should check if membership and, perhaps more importantly, ongoing employer funding would stop. A partial transfer could be the answer if this is a problem.

Workplace pensions can sometimes have associated death-in-service cover which could be lost if the pension funds are transferred.

Protected tax-free cash or pension age

There’s an additional complication when consolidating if a scheme has:

• an entitlement to more than 25% tax-free cash under ‘scheme-specific tax-free lump sum’ protection or
• a protected low pension age

Unless the transfer is part of a ‘block transfer’, the protection will normally be lost. However, protection can sometimes also remain on certain individual transfers or on scheme wind-up.

Our technical guide 'Pension transfers – DC to DC' has more information on this.

Where a block transfer is possible, there are still a couple of issues to be aware of.

• Membership of the receiving scheme
  The block transfer is normally ineffective for any member who has been a member of the receiving scheme for more than 12 months – that individual would normally lose their low age or tax-free cash protection. The exception is the protection of a low pension age of 55 or 56.
  
  For this reason, where block transfers are concerned, the schemes are normally consolidated into a new scheme rather than one of the existing schemes.
• Phasing benefits
  A requirement of a protected tax-free cash entitlement or low pension age is that all the benefits are crystallised at the same time. So consolidating pensions involving a scheme with such protection effectively removes some flexibility because it’s not possible to take the benefits in stages (often referred to as ‘phasing’ benefits). The exception is the protection of a low pension age of 55 or 56.
  
  So, for example, those with protected tax-free cash would have to take it all in one go.
  
  Where this doesn’t fit with the client’s strategy for taking benefits, consider keeping the schemes with protection separate.

If two or more schemes have protected tax-free cash

If someone has two or more schemes with protected scheme specific tax-free cash rights, these rights can't be consolidated into the same pension scheme without losing some tax-free cash protection.

Only the first protected scheme specific tax-free cash held under a pension scheme can be protected. Any other benefits transferred into that scheme only come into the second 'extra lump sum' part of the protected tax-free cash formula.

For more information on scheme-specific tax-free cash calculations, see our technical guide on 'Scheme-specific tax-free cash protection'.

The effect of consolidating in such circumstances is best demonstrated in with an example.

If the difference in tax-free cash entitlement is minimal, a transfer might still be appropriate if that provides the benefits required by the client. If the loss of tax-free makes a transfer unfeasible, then consolidation could possibly be considered after the client has taken all of their tax-free cash - if the schemes allow it.