Alternative lower risk workplace pension scheme launches
Collective Defined Contribution (CDC) pension schemes are now open for applications in Great Britain and sit alongside Defined Benefit and Defined Contribution options.
Before today, there were two main choices for workplace pensions, with the increasingly rare Defined Benefit (final salary) scheme which is based on earnings history and length of service.
The other is the Defined Contribution scheme where an individual pays into an account with contributions invested. At retirement, the funds can be withdrawn as a cash lump sum, converted to a drawdown scheme or used to buy an annuity.
The third CDC scheme provides pension savers with a ‘middle-of-the-road’ option, almost a hybrid of the existing two pension schemes where employers and employees contribute to a collective fund from which individual retirement incomes are drawn.
As workers’ pension contributions are pooled together into one pot, longevity risk is shared between members. It also takes away the decision-making process for members about the investment of funds and how to convert the fund into an income stream at retirement.
Trustees are responsible for oversight to ensure schemes are viable and can meet their legal requirements and commitments to members.
However, one of the drawbacks is that the benefit level offered is an estimate, not a guarantee, so the amount received by members may be lower than expected. As it works on cross-subsidisation, it could result in current and future employees have to “bail-out” older generations.
CDC schemes are already used in the Netherlands and in 2018, the Department for Work and Pensions launched a consultation setting out the framework for the alternative CDC pensions here in Great Britain.
Initially the CDC schemes are likely to be offered by larger employers with The Royal Mail already committing to providing this scheme for workers.
Minister for pensions, Guy Opperman, said: “CDC schemes have the potential to transform the UK pensions landscape.
“We have seen the positive effect of these schemes in other countries and it is abundantly clear that, when well designed and well run, they have the potential to provide a better retirement outcome for members, and can be resilient to market shocks.
“I have no doubt that millions of pension savers will benefit from CDCs in the years to come.”
‘Important to understand the complexities’
Steven Cameron, pensions director at Aegon, said CDCs are “designed to give members more assurances of the benefits they’ll receive compared to Defined Contribution schemes where members bear all the investment risks, while avoiding the guarantees of Defined Benefit schemes which place a highly costly unlimited funding liability on employers”.
Cameron said: “An underlying concept is members share risks of investments outperforming or underperforming and also of some members living much longer, so receiving their pension in retirement, longer than others. However, there are many complexities and it will be important that members understand these, including that ‘target’ benefits are not guaranteed and can go down as well as up even once their retirement income is being paid.
“Rightly, new legislation sets very stringent rules for the running of such schemes, to make sure they are designed fairly, run on a financially sound basis and provide good member outcomes. They must also be equipped to explain the many complexities to members. This is crucial as many of the millions who are automatically enrolled may not currently ‘engage’ with the details of their scheme.”
Becky O’Connor, head of pensions and savings at Interactive Investor, added that access to the new CDC schemes is dependent on where people work so they “shouldn’t get too excited”, as “you won’t be able to simply choose a CDC for yourself”.
O’Connor, said: “For the time being, Defined Contribution schemes remain the most likely type of pension someone will find themselves enrolled in through work. With these, what you get out at the other end of a lifetime of saving remains largely in your own hands, with employer contributions generally lower than those from the employee.
“However, if your employer does happen to offer generous contributions that match or even double match your own up to a level higher than the auto-enrolment minimum, it’s wise to take advantage if you can.
“For people who want control of their own pension investments, CDCs are unlikely to appeal as much as Self-Invested Personal Pensions.”