Ensuring working people enjoy a decent standard of living in old age has come a step closer with the publication of government plans to allow a new form of collective pension scheme.
Collective defined contribution (CDC) pensions are a half-way house between the two key pension types in the UK: defined benefit (DB) and defined contribution (DC) schemes.
Trade unions continue to fight for and defend DB pensions, which pay a pension based on salary and service.
But these days most workers are in DC schemes, which deliver a pot of money from member and employer contributions plus growth from investments such as company shares.
By contrast CDC schemes are collective, so members don’t make their own choices about the investment of funds. Instead their money goes into a common pot, and when they reach retirement the scheme pays an income.
But this pension is a “target” income not a firm promise, unlike defined benefit schemes where employers on the hook for any shortfall.
So payments might be higher or lower than targeted due to performance of investments or members living longer or shorter than expected.
There has been a growing consensus that companies in the UK should be allowed to establish CDC schemes, which are commonplace in the Netherlands and Canada.
But the real impetus has come from the CWU trade union, which thrashed out a deal with Royal Mail after securing a huge mandate for industrial action to ensure 144,000 postal workers received decent pensions.
The result has been this week’s consultation paper from the government, which lays out how rules allowing CDC schemes might work.
There are three very good reasons to view CDC pensions as positive for working people:
1. They should provide more security and predictability
Our research shows that a typical DC saver could be £5,000 a year poorer in their old age if they retire after a bad spell for pension funds rather than in a good year.
Collective DC schemes allow savers to pool their money into one fund rather than save into their individual accounts.
The risk of investing is then shared by all members of the scheme, not shouldered by one individual alone.
2. They provide a straightforward way of generating an income in retirement
The introduction of pensions freedom ended the old system where DC savers bought an annuity contract giving them a lifetime income on retirement.
As a result, it’s hard for savers to generate income in retirement if that is what they require.
CDC pensions are designed to pay an income, and their collective nature means the risk of living longer than expected is shared between members.
And because assets stay invested, that income should keep pace with inflation.
3. They are likely to be cost effective and could offer better returns to savers.
The UK has tens of thousands of little DC pension pots.
Large collective schemes should have economies of scale, but the fact that assets don’t have to be sold to buy an annuity means savers remain exposed to real assets (and therefore the potential for above-inflation returns) through retirement.
Schemes can hold onto illiquid assets (perhaps the sorts of infrastructure projects that governments are so keen to tap pension schemes for), and get paid higher returns as a result.
There are also some vocal opponents of CDC.
They argue that savers will not know what they will receive in retirement, especially if markets have a tough time.
But this is also the case for many savers in the purist DC schemes that currently dominate the market, as they are exposed to the vagaries of investment markets as their savings build up.
Many who take money directly out of their pension in retirement will also see their income fall or dry up if investments head south.
Opponents also argue that there’s a lack of demand among employers to offer CDC.
But given the enthusiasm of Royal Mail and its 140,000-strong workforce, it seems likely that other large employers will follow suit.
Of course, CDC will not be for all employers, but in many places CDC will be a good option.
This is not to say that the government’s proposals are perfect.
First, they are limited in scope because the government is minded to rule out multi-employer CDC schemes.
This would prevent industry-wide schemes, for now at least.
There is also no mention of using CDC approaches for retirement income alone.
This would be a useful tool for UK’s rapidly growing set of master trusts, multi-employer pension schemes typically catering to low and middle-income workers.
But with the prospect of legislation for CDC in 2019, this is an important step in improving the UK’s retirement provision.
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