Need to know:
- Collective defined contribution (CDC) pensions potentially offer a more sustainable way of funding pensions and reducing pension liabilities for some employers.
- Their potential to provide a more secure and predictable retirement income for employees could help to close the retirement savings gap that leaves many workers with insufficient retirement income for later life.
- Clear and effective communication from employers will be key to keeping employees well-informed about the implications and benefits of CDC schemes.
In April this year, the UK’s first collective defined contribution (CDC) pension scheme, the Royal Mail Collective Pension Plan (RMCPP), was authorised by The Pensions Regulator (TPR), a deal that could potentially change the UK pension landscape. An alternative to traditional defined benefit (DB) and defined contribution (DC) pension schemes, CDC schemes pool member and employer contributions in a collective fund from which an aspired to pension income for life is drawn.
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While the pensions industry has generally been positive about the emergence of CDC pensions, it is keen to see progress in two key areas, the extension of the stand-alone CDC arrangements to allow multi-employer designs, and the provision of at-retirement CDC options, says Iain McLellan, director of research and development at pensions consultancy Isio.
“Multi-employer schemes should open up access to CDC benefit provision to more employers as it would remove the requirement to have a large workforce in order to access the scheme and avoid any one employer having to bear all of the material set-up costs,” he explains. “At-retirement CDC options would allow DC members to use their pot to provide a CDC income in retirement in combination with, or instead of, the traditional options of a certain, although expensive, annuity and drawdown which runs the risk running out of money in retirement.”
These schemes, already established in countries such as Canada, Denmark and the Netherlands, offer a regular retirement income but in the form of a target benefit rather than DB schemes’ guarantee. They are being seen as potentially offering a more sustainable way of funding pensions and helping some employers reduce their pension liabilities. However, some industry comments have highlighted the complexity of implementation in line with the current pensions system, risk of investment losses and the possibility of giving some long-term savers less flexibility and choice.
From an employee’s perspective, CDC is closer to a DB scheme than a DC scheme. However, because it will provide a target pension income that will not be guaranteed, in the same way it is under a DB scheme, employees will want to understand how their CDC scheme is performing and whether the level of pension increases being targeted are being delivered in practice.
Pete Hykin, chief executive officer (CEO) and co-founder at Penfold, says: “For employees, understanding the impact of this decision is paramount. While the transition to a collective approach may bring about changes in the way retirement benefits are structured and managed, it is vital for employees to grasp the potential advantages of risk pooling, diversified investments, and greater stability in funding. Clear and effective communication from employers will become indispensable in ensuring that employees are well-informed about the implications and benefits of CDC schemes.”
Another consideration is how CDC schemes might affect the retirement outcomes of employees. CDC schemes can help shield employee members from volatile investment markets by pooling the risk and mitigating exposure to short-term investment losses, says Sam Holmes, head of financial coaching at financial wellbeing consultancy Bippit.
“Individual members of these schemes will retain flexibility and be able to tailor their retirement planning to their individual needs and circumstances,” he says. “In theory, it could be the best of both worlds. By minimising the risk and complexity of retirement planning for employees, while maximising security of income, CDC schemes offer the potential for employees to enjoy a more comfortable retirement safe in the knowledge that they will never run out of money.”
CDC schemes could become a more popular alternative to traditional DB schemes, whose popularity has declined in the private sector due to employer funding obligations and large-scale deficits seen in larger schemes in the past. They offer a more affordable and flexible alternative for both employer and employee, while their potential to provide a more secure and predictable retirement income for workers could help address current concerns that many future retirees will have too little income to survive on in later life. The big question is, how many employers are likely to follow Royal Mail’s lead?
Jamie Jenkins, director of policy and communications at Royal London, says: “The Royal Mail scheme has been agreed between the employer and the workforce following a lengthy negotiation, and is a relatively bespoke arrangement to deal with its particular circumstances. It may well be of interest to other employers yet to move away from DB pension provision, but we see limited demand from those employers which have already made the switch to DC.”