Written by Shaun Robson, Head of Wealth Planning and Partner at Killik & Co
In April, The Pensions Regulator authorised the Royal Mail Collective Pension Plan, making it the first time in the UK that a Collective Defined Contribution plan (CDC) has been available to the public.
CDCs are already popular in parts of Europe and Canada and look to strike a necessary balancing act between current Defined Contribution (DC) schemes and previously fashionable Defined Benefit (DB) schemes. The Pensions Scheme Act of 2021, which CDC was approved under, does allow provisions for the scheme to expand in the UK, but is this scheme going to shake up the industry or will it just add another layer of complexity on top of what already exists?
How do CDC schemes work?
In a CDC pension, employees and employers contribute to a collective pension fund, pooling the contributions of multiple members rather than having individual accounts like in a DC plan. These investments are managed collectively with the scheme’s performance and longevity risk being shared among members, aiming to provide a more predictable retirement income. Unlike other popular schemes, CDC pensions do not guarantee a set pay out or fixed pot of money, but instead provides a targeted retirement income for its members which is adjusted based on contribution levels and performance.
How do they differ from what already exists?
Under a DB pensions scheme, employees are promised a predetermined monthly income amount at retirement, and it is employers who are charged with dealing with any shortfalls. Under DC schemes, however, it is employees who bear the final responsibility for their retirement income through how much they contribute, and investments returns. CDC pensions look to strike a middle-ground between the two, pooling contributions and sharing the risks and rewards between all the parties involved. This shared risk allows for the smoothing of investment returns and the pooling of longevity risk, potentially mitigating the impact of market volatility and offering more stable retirement income.
What are the benefits?
The main benefit of a CDC scheme lies in the collective approach. Contributions are pooled together, thereby spreading the investment risk out between all members and making the fund more resilient to market shocks. Employers tend to like them because their contributions are fixed, making the cost easier to factor into annual budgets. For employees, they offer a potentially more predictable retirement income that requires lower responsibility on their part, reducing the uncertainty associated with market fluctuations and investment risks inherent in DC schemes.
What are the drawbacks?
The main consideration when it comes to CDC schemes remains that retirement income levels are not promised, and the set target may well not be reached. The fact that all contributions are pooled together, and investment decisions are made collectively also leaves the individual with limited control over their pot, potentially limiting their ability to adapt to changing circumstances.
Will it catch on?
There is definite potential for CDC pensions to catch on, with the key determinant being how far the government backs them. In the Netherlands and Canada, CDC pensions evolved out of DB pensions and is considered the first state-sponsored pillar of pensions. However, in the UK, the application
process is currently only open to single-employer schemes, such as the Royal Mail, and remains inaccessible to larger master trusts, this will impact its take up.
That being said, in January this year, the government launched a new consultation into the potential for extending the CDC schemes to master trusts and multi-employer groups. If the results are positive and these schemes are allowed to expand in the same fashion as they are in other places, they may indeed prove quite popular to employees who are seeking a more reliable income and employers who like the idea of the predictable costs, lower levels of administration and shared risk.
While CDC schemes have the potential to simplify retirement planning, their introduction may add complexity to the pension landscape. Striking the right balance between innovation, consumer understanding, and effective regulation will be crucial in determining their future trajectory.
