Government plans to modernise workplace pensions have been described as a potential “bridge between the old gold-plated defined benefit (DB) schemes… and the defined contribution (DC) schemes” that most private sector employees now have.
The Department for Work and Pensions shared its plans as part of a consultation launched this week on extending Collective Defined Contribution (CDC) pension provision.
On a recent visit to Canada, chancellor Rachel Reeves saw how retirement schemes there successfully pool contributions from employees into larger funds that are managed by investors.
As a result, the UK government is “fast-tracking” plans to modernise its own pensions system by broadening access to CDC schemes.
Combined elements
CDC is a type of pension scheme that combines elements of DB and DC. With individual DC schemes, each member has their own pension pot, but with CDC the contributions are pooled in a collective fund.
The advantages of pooling include the potential for higher returns on investment, being able to share the investment and longevity risks across all members, as well as a more stable retirement income.
However, there are drawbacks. Member may see a reduction in benefits if investment returns are lower than expected, individuals have no control over how contributions are invested, and there is less flexibility around how and when savers can access their pension.
Multiple employer CDCs
While individual or connected employers can have their own CDC scheme, the government proposes allowing multiple employers to share a scheme, which could lead to more firms adopting this system.
Gary Smith, financial planning partner and retirement specialist at wealth management firm Evelyn Partners, said: “As well as promising to deliver better outcomes for pension savers, this initiative is also aimed at ‘supporting the government’s growth mission’ by getting pension funds to invest more in UK companies and infrastructure initiatives.
“Currently of the £830 billion in UK pensions only 4.4 percent is invested in domestic equities, partly because investors have been put off by their lacklustre growth of recent years.”
DB to DC bridge
He continued: “The CDC idea can seem attractive as a bridge between the old gold-plated DB schemes, which are now all-but extinct in the private sector, and the DC schemes that the vast majority of private sector employees are now members of – and auto-enrolled into when they join a new company.”
However, he said that while CDC schemes are similar to DB schemes in that one big investment fund is managed to pay target pension incomes to its retiring members, “crucially that income is not guaranteed”. This means CDC schemes are “not ‘gold-plated’, in that members might end up with a lower income than they had expected if the fund’s investment returns underperform”.
Smith said: “In such a situation, how reduced incomes are applied to current rather than future retirees is a major question and one that will depend on how the scheme is run.”
Good performer
He said that CDC schemes benefit, in theory, from economies of scale, pooling of risk and professional investment management – but if they will have a weighting towards UK equities, start-ups and infrastructure investments then you’d need some faith that these investments would actually pay off.
“Compared to a traditional DC scheme, which has a choice of funds that members can funnel their own contributions into, it looks like savers into CDC would be surrendering quite a bit of control and choice over how their pension is invested.
“That might well suit some workers but in return for surrendering control they will probably want some assurance that their scheme will be a good performer. How that assurance can be provided – at least in a scheme’s early days – is unclear. From a recruitment perspective, if an employer solely offered a CDC arrangement then some workers who had strong preferences on how they wanted their pension to be invested might be put off joining.”
Seizing innovation
Commenting on the plans, minister for pensions Emma Reynolds said: “We are seizing this exciting opportunity to modernise our pensions market to deliver better outcomes for millions of workers.
“People work hard to put money aside for their pension with every pay cheque. This significant innovation will offer a more predictable income and greater finance security for future pensioners.”
Nausicaa Delfas, chief executive of The Pensions Regulator, said: “Multi-employer CDC pension schemes offer the potential to deliver better outcomes for thousands of UK pension savers, turning a pension pot into a retirement income.
“I encourage industry to take part in the consultation and we look forward to working with government to develop an appropriate regulatory regime.”
