There are currently two main choices for workplace pensions.

One is the gold-plated defined benefit scheme which is based on earnings history and length of service, though these are increasingly rare.

The other is the defined contribution scheme where an individual pays into an account, contributions are invested and then at retirement are withdrawn as a cash lump sum, converted to a draw-down scheme or used to buy an annuity.

But the government has today published a consultation setting out the framework for an alternative – CDC pensions.

With these products, workers’ pension contributions are pooled together into one pot so longevity risk is shared between members. They also take away the decision-making process for members about the investment of funds or how to convert the fund into an income stream at retirement.

But on the negative side, the benefit level offered can only be an estimate or target, not a guarantee so the amount received may be lower than expected. Further, the scheme works on cross-subsidisation method so there may be a scenario where current and future employees need to bail out older generations.

As part of the Department for Work & Pensions consultation, it’s seeking feedback on the proposals, with the aim of legislating CDC schemes in England, Wales and Scotland ‘as soon as Parliamentary time allows’.

CDC schemes are used in the Netherlands and the move by the DWP follows steps taken by the Royal Mail and the Communication Workers Union work to set up a CDC scheme in the UK.

‘Communication absolutely essential’

Tom Selby, senior analyst at AJ Bell, said outcomes in CDC will be less predictable and raises the spectre of pension cuts should investments consistently underperform over a long period of time.

“The DWP itself notes any reductions in benefits will not be well received, and so clear communication of this – not just upfront but on an ongoing basis – will be absolutely essential.

“Simply referring disgruntled members to a complex set of scheme rules they signed up to blindly years ago won’t be good enough. Getting these communications right will arguably be the biggest challenger for employers who choose to go down the CDC route.

“Given the sheer size of Royal Mail as an employer, its demand for CDC was always likely to catch the attention of the government and crystallise thinking around how such schemes will operate on a practical level. It remains to be seen whether other employers will share its enthusiasm.”

Steven Cameron, pensions director at Aegon, added: “The CDC concept in other countries places restrictions on when and how benefits can be taken and on transferring into another scheme. Applying equivalent restrictions in the UK would conflict directly with the huge popularity of the UK’s pension freedoms.”