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A watchful eye

Mon 07 Jul 2014

As concerns over pension pots grow, the Government takes action. But is PFM really the best solution?

Although its intentions are good, the Government’s proposal for dealing with the growing number of small pension pots could have serious consequences. “The Government’s current plans could have a huge impact on both members and those involved in the administration of work-based defined contribution (DC) pension schemes,” says Peter Scott, Technical Consultant, Equiniti Paymaster.

This is down to the Pensions Act 2014, which contains the framework of the government’s proposed pot-follows-member system (PFM). “The new PFM system will see work-based DC pension funds automatically follow employees when they change jobs,” Peter explains.

The details of PFM will be set out in regulation yet to be published. In its current form, PFM only applies to funds that are less than £10,000 and have been created after a date to be set out in the regulations. Older pots may be dealt with at a later date.

“Under the Pensions Act 2014, PFM will apply to so-called automatic transfer schemes (ATS),” Peter says. “An ATS is currently defined as a registered work-based money purchase pension scheme that meets with any prescribed conditions. As of yet, we don’t know what these ‘prescribed conditions’ are likely to include.”

The trustees of an ATS will have to issue a transfer notice to another scheme where they find that a member has transferable benefits under that scheme. The transfer notice will request the transfer of the cash equivalent of the member’s benefits to the ATS. “Once the transfer notice has been received, the other scheme must do everything necessary to effect the transfer,” Peter says. “But the member will, however, be able to opt-out of the PFM process.”

One of the main practical issues with PFM is how the ATS will find out that a new employee has pension rights under another pension scheme. In order to establish this, the Government has put forward two options: either a central pot-matching IT-based solution, or a pensions transfer information document similar to a PAYE P45 that the employee passes to their new employer when they start work.

“Government has yet to make a final decision as to which system it prefers,” Peter says. “But how much appetite there will be in central government for beginning yet another major IT-led project remains to be seen.”

As Peter explains, PFM will also introduce an additional level of complication in the administration of DC schemes. “This could pose a particular problem for those large national schemes which have grown out of the auto-enrolment legislation and which are likely to see a large increase in transfer activity – both in and out.”

The Pensions Act 2014 also contains provisions allowing for PFM-specific disclosure and record-keeping duties, and financial penalties may be imposed on those who fail to comply.

“Nobody can argue with the sentiment behind PFM. It is, after all, intended to help people manage and keep track of their pension savings,” says Peter. “Time will tell whether or not this will have the desired effect.”

Potential pitfalls

Critics of PFM have pointed out the following shortcomings that they feel have not been adequately addressed:

  • Fees in the receiving scheme could be higher than those under the transferring scheme.
  • A member’s retirement savings could be moved to a scheme with a less robust governance structure.
  • Repeatedly switching retirement savings out of investment assets into cash and back again might expose a member to multiple charges, reducing the eventual level of their fund at retirement.
  • Automatic switches will not take account of current market conditions, requiring members to be market savvy and opt-out in order to avoid being moved at a bad time.