Why consolidating your pension is sometimes a big mistake

If you're employed, aged 22 or older, and earning more than £10,000, it's likely you're paying into a pension scheme.

And while in days gone by it was normal to find a job and stay there, many people today will have collected several pensions from leaving and starting different jobs with different employers.

Consolidating pensions can make sense - it's easier to track and reduces the administrative burden of having pension pots in different places.

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But it's not always as straightforward as this - and there are potential pitfalls.

Here are seven questions to ask yourself to make sure consolidation is right for you in the long term...

What kind of pension am I considering moving?

Sarah Coles, head of personal finance at investment platform AJ Bell, says pensions broadly come in "two flavours" - defined contribution and defined benefit.

Most modern pensions are defined contribution, where you - and your employer if it's a workplace pension - pay a fixed sum each month.

That money is invested and grows over time, building up a pot that will pay you a retirement income through an annuity, drawdown or a lump sum.

Meanwhile, defined benefit pensions give you a retirement income based on your salary and how many years you've been in the pension scheme. They provide a regular income for life, usually in monthly payments.

Coles says it's easier to weigh up the costs and benefits when combining one defined contribution pension with another, while it's a "very different beast" when switching from defined benefit to defined contribution.

"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," she says.

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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", Coles says.

One of the advantages is that, once you reach the minimum pension age, you may be able to cash in the entire pot without affecting some of the pension allowances that apply when accessing larger pensions.

Coles says this can be a useful reason to keep some small pension pots separate rather than consolidating them into a larger one.

However, anyone considering this should be aware that taking taxable income from a pension can trigger the money purchase annual allowance, reducing the amount that can be paid into pensions with tax relief each year from £60,000 to £10,000.

What are the charges in my current pensions?

Older pension schemes often charge more than newer ones, says Coles.

Though there's a government-set charge cap of 0.75% on default funds in automatic-enrolment workplace pension schemes today, many pension policies, including older contracts or those set up outside auto-enrolment, may carry higher fees, she adds.

"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."

What charges will I pay to leave?

If you've opened a pension since 2017, you won't face any exit penalties, but older pensions may have them, Coles warns.

Some kinds of pensions cap such charges at 1% for people who have reached minimum retirement age, and fees are banned if you're over the normal scheme retirement age.

People who have a with-profits pension (where a group of savers pay into one fund, which is then invested) may face what's known as a market value reduction if they withdraw or transfer their pot at a time of poor market conditions.

"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," says Coles.

"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."

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Is there a guaranteed annuity rate?

Some older pension schemes guaranteed an annuity rate at retirement, 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," says Coles.

Is there a protected lump sum?

While some older pensions offered a tax-free lump sum of more than a quarter of the pot, all modern schemes are limited to 25%, says Coles.

"If you switch away you will typically lose this, unless you can find someone else to transfer with as 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."

What pension should I move to?

Consider what you want from your new provider before moving, Coles advises, such as the information and support on offer, any charges and whether they're offering value for money.

"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 from an investment platform is likely to offer far more choice than a traditional pension provider," she says.

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