What is a collective defined contribution pension?

[RobertT]

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The government has been looking at ways to offer better pensions for millions saving for their retirement. Currently in the UK, most people are likely to be members in either a final salary pension scheme provided by the employer, or a defined contribution plan, which may be employer-sponsored or private. Now the government wants to introduce a type of collective pension plan that is already operating in some other countries, notably the Netherlands and Canada, and claims these “collective” schemes could deliver more stable retirement income.

What are collective pension schemes?

Most defined-contribution savers in the UK are build up their pensions in an individual account. These offer no certainty about the size of pot the saver will have in retirement – it’s determined largely by investment performance and costs. But under Collective Defined Contribution schemes, everyone’s money is aggregated into a single pot, reducing investment uncertainty and providing economies of scale. Income is paid directly from the savings fund.

How do they work?

CDC schemes are offered in the workplace, like other company pensions. Both the employer and employee make contributions to build the pot. Members are also provided with a “target income” in retirement. However, this is not a firm promise, like the one given to members of traditional final salary-linked pension schemes.

Under the collective model, all members share the ups and downs of investment performance. This means that in bad times, pensioners may face income cuts or savers may be asked to make bigger contributions. Market shocks are absorbed by the group fund, which should reduce the impact on any individual member.

In other countries, such as the Netherlands, a board made up of investment managers and unions makes decisions about who will “win” and “lose” as the fund’s returns are smoothed. Advocates point out that Dutch pensioners saw income cuts of between 2-6 per cent after the 2008 financial crisis, even though stock markets fell by much more. The concept is similar to with-profits funds, where investment returns are also smoothed.

Are the claims of bigger income true?

Politicians have claimed that pooled pensions could deliver up to 30 per cent more income because of the risk-sharing and lower costs. But these claims have been challenged; some say they are based on overseas models and not achievable in the UK.

What are the benefits?

Less uncertainty and the sharing of risk are the main ones. Someone saving into their own pot bears all the investment risk and has no certainty about the eventual outcome.

The size of these schemes means they can deliver cost savings and investment choice not so easily achieved by individuals with modest savings. Individuals are given a “target income”, which makes financial planning easier.

And the disadvantages?

Pooled pensions share the risk across those still saving and those already drawing their pensions from the same fund. This introduces issues of intergenerational fairness. During economic downturns, young members may be asked to make bigger contributions to ensure that older members’ benefits are maintained.

CDCs are not the same as final salary schemes. There are no guarantees regarding the income provided at the end.

Will I be able to get my cash at age 55?

In other countries, savers in these pooled schemes are paid an income from the fund, with little flexibility to take the benefits as cash. This is potentially incompatible with new freedoms being introduced from April 2015, which will allow savers to take their sums from an individual defined contribution pension with less punitive tax charges once they are 55. Steve Webb, the pensions minister, has said the new collective schemes “would have to be adapted” for the British system.

When could they be offered to British savers?

Changes allowing the new schemes be offered to British workers need to be passed by parliament. Industry experts believe the first schemes could be up and running by April 2016.

Can I switch to a pooled pension?

That decision usually rests with the employer. If your employer decides to switch its existing scheme to a pooled arrangement, and you wish to retain an individual account, then you may lose the valuable employer contributions to your pension.

These schemes need scale to work best, so they are most likely to be offered by big employers rather than small and midsized firms. So far, there has been muted appetite among employers for switching schemes to the collective model. It is thought that many would prefer to stick with their existing defined contribution arrangements, since these effectively transfer risk away from the company and on to the employee.

[jetblack]

For risk to be 'pooled'/shared then investment choice must by necessity be limited. How can risk be pooled if I hold a penny stock and you hold gold ? Doesn't work. So we'll have the choice most likely of a half dozen large funds.

Might work for some, but, for me personally, this (at first glance) is horseshit.

Stop shifting the burden onto the state RMG - pay your dues to provide your workforce a decent guaranteed minimum pension in retirement. Let us know what level you can gaurantee - and then we all know where we stand and can take it from there.

This is one step up from zero hours contracts on the retirement front. I show all the 'flexibility' - the employer shows none. Thats whats known in traditional parlance as exploitation.

[RobertT]

We wouldn’t get a choice as to where our contributions were invested, the trustees and their advisors would decide that. The returns would then be averaged over time in a similar way to a with profits fund.

I don’t believe there could ever be a 100% guarantee of a certain level of income with a CDC pension. Although as no legislation has been passed in the UK regarding these type of pensions as yet, we can only go on what happens in other countries.