Current rules make it difficult for people to combine their pension pots as they move jobs, leaving money stranded or lost completely. Without action 50 million pension pots could sit dormant by 2050.
Creating a system in which small pots follow people through employment is the preferred approach among savers, according to a recent survey by the Association of British Insurers.
Announcing that the Government will develop a 'pot follows member' design, minister for pensions, Steve Webb said: "We need a system where people build up worthwhile pension pots in one place rather than having lots of small pots all over the place. But at the moment every time someone moves to a new job there is a risk that they leave behind a small pension pot which they lose track of. Our plans will mean that individuals get better value for their savings and bigger pensions as a result."
"Automatic enrolment will help millions of people save into a pension, with a contribution from their employer. Our overall goal of getting millions more people saving would be completely undermined if people are let down by a set of rules that mean people lose track of money saved and miss out on vital income in retirement."
The DWP consulted on approaches, including a suggested central aggregator. The 'pot follows member' model will give far greater levels of consolidation and could halve the potential number of dormant pots by 2050.
It would also provide the best reduction in administrative costs for pension providers in the long run, potentially offering further benefits for savers in the form of lower charges.
Joanne Segars, NAPF chief executive, said: "We all agree that the increasing number of small pots is a problem that needs tackling, especially with auto-enrolment around the corner.
"Small pots mean that people could get worse retirement outcomes, with higher charges eroding the value of people's hard-earned pension saving.
"While the Government's idea is one way to solve the problem of small pots, it does not tackle the risk that people might see their pension transferred to a worse scheme with higher charges and weaker governance. There is a real risk of a pensions lottery where people could be automatically transferred into better or worse schemes without them being aware of the impact. It will be interesting to see how the DWP's plans will ensure better outcomes for members.
"We believe a better solution would be to allow people to transfer their pensions into large-scale, low-cost aggregators which are simpler and better placed to deliver good member outcomes. We urge the Government to reconsider its preference for 'pot follows member'."
The NAPF calculated that if someone with a pension pot of around £10,000 and an annual management charge of 0.5% was then moved into a pension with an AMC of 0.9% a year, then they would lose around £1,500 or 10% of their pot after 25 years.
