Q&A: What are collective pension schemes?

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The government has officially announced plans to introduce collective pension schemes, a new way for employees to save for retirement.
Q&A: What are collective pension schemes?

Similar schemes are well-established in countries such as Holland and Denmark but are brand new for the UK.

Ministers say savers could boost their retirement income by more than 30 per cent using these plans, which are also known as collective defined contribution schemes – or CDCs.

What is a CDC?

This new type of pension plan allows workers to pool their savings with those of others rather than investing on an individual basis. The idea is that all members share the risks and rewards of pensions savings.

Employers will pay a certain amount each month into a CDC and the scheme pays out a regular pension to members after they retire. The aim is to pay the member a proportion of their career average salary, with the amount increasing in line with inflation. However, this is a target, not a guarantee.

Who manages a CDC?

Unlike individual defined contribution schemes, where the saver has to make often complex investment decisions, CDCs are managed by trustees who act on behalf of all members.

The ultimate payments are determined by actuaries who make forecasts of future returns and life expectancy of members.

Will I really get 30% more income with a CDC?

According to David Pitt-Watson, an executive fellow at London Business School, pooled pensions can provide a 30 per cent plus higher pension payment than individual pensions where savers buy an annuity.

Claims that CDCs can make everyone richer are based on the idea that pensioners’ savings could stay invested in equities rather than being used to buy annuities. “But pensioners can do that anyway, especially since the Budget,” says Will Aitken, a consultant at Towers Watson.

What are the disadvantages of CDCs?

• Younger members may end up subsidising older members. According to Aitken, younger savers will have to “ride to the rescue” when markets disappoint, while some of the upside will be kept back from pensioners when things go well. Some commentators have even gone as far as describing CDCs as Ponzi schemes.

• Lower earners, who have lower life expectancies than higher earners, may end up subsidising higher earners.

• Benefits are not guaranteed and there is a sense of ‘with-profits’ about the scheme – increasing income when the scheme does well and reducing income if the scheme does not perform, as happened for many Dutch CDCs after the last economic downturn.

• People may find it difficult to transfer out of them when they change jobs.

• It is not clear whether the sweeping freedoms to how people draw their pension – announced in the Budget – will apply to those in CDCs.

Will there be demand for CDCs?

There are conflicting views as to just how many employers will be interested in offering CDCs to workers.

The CBI says the complexity of these schemes mean they are likely to be offered by only “a few large employers keen to provide their employees with something more predictable than existing defined contribution schemes”.

Meanwhile, Tom McPhail of Hargreaves Lansdown says employers are more concerned about auto-enrolment, the impending pension charge cap, the impact of the Budget, and getting employees engaged.

“In the Netherlands, employers are looking to the UK model of pension provision and wondering whether they should adopt our approach,” he says.

However, Claire Trott, of pensions specialists Talbot & Muir, believes CDCs could become a “default occupational scheme of the future”.

“CDCs are likely to appeal to those employers that want to offer a more guaranteed outcome to their employees as the benefit to retain them but are not in a position to offer a Defined benefit scheme. They give more of a guarantee but take away the issues with spiralling contributions and the big unknown costs of defined benefit (DB) schemes,” she says.

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