Adrian Boulding: Advice opportunities in CDC decumulation

[TrueBlueTerrier]

https://www.professionaladviser.com/opi ... cumulation

CDC decumulation could offer a healthy balance between risk and reward for pension savers planning decumulation but will all DC savers be offered this option? Adrian Boulding looks at the issues for advisers
The Department for Work and Pensions published its draft collective defined contribution (CDC) pensions scheme regulations and ran its consultation on these changes earlier in the year. Once these regulations are firmed up, by the end of this year in all probability, single employer and connected employers within a group structure will be able to open CDC schemes for their employees.

Back to where it all began

Let's not forget how CDCs first made it onto the table as a new occupational pension offering way back in early 2017, when the Royal Mail announced that it would have to close its final salary Royal Mail Pension Plan to future accruals from March 2018 due to the unsustainable indebtedness that it was incurring for the now private organisation.

In intense discussions with the Communication Workers Union and the Advisory, Conciliation and Arbitration Service, the Royal Mail put forward the recommendation of replacing its old and unaffordable DB pension scheme, with the UK's first CDC pension scheme to avert a potential strike.

Under the terms of the Royal Mail CDC scheme members, who will be auto-enrolled in a similar manner to DB and traditional DC schemes, will need to contribute 6% of pensionable pay, while their employer will contribute 13.6%. Members will also benefit from a lump sum at retirement.

We've come a long way to reach this point over the last five years but now things are set to move fairly fast. Once CDCs go live for single employer and connected employers, from early next year, a second consultation is likely to be offered by the DWP to explore extending the availability of CDCs much more widely.

Such is the positivity with which CDCs are now talked about in government circles, that it is definitely worth exploring the possibility that master trusts could be given permission to offer CDCs as another decumulation option to those of us that have built up retirement savings in any other DC pension schemes.

Future Decumulation Option for all?

As this is a real prospect within the next couple of years, it's worth considering why workplace advisers (for now) might consider advising people in the direction of CDCs at retirement. To answer that question, it's important to understand what's similar and different about CDCs as compared with income drawdown and annuities which are the other two big decumulation options once we get beyond the majority that are still cashing in their entire pots at retirement.

CDC decumulation, like annuities, will offer a regular monthly income in retirement for the entire life of the buyer. CDCs, once in decumulation, will also offer the prospect of retirement income increasingly yearly in line with prices, thus preserving a pensioner's standard of living. The expectation is for a substantially higher pay out over the duration of retirement. The Royal Mail's CDC will sit alongside a DB lump sum at the start of decumulation.

Performance upside

A 2009 Government Actuary's Department (GAD) study found that the median improvement in outcome offered by CDCs "is as high as 39% for some members." And a 2012 paper by the Royal Society of Arts (RSA) calculated a 37% boost to retirement income outcomes through CDC.

How is this possible? There are a few reasons: CDCs, as the name suggests, are collective schemes which pool the risk across all members of a scheme. This ‘longevity pooling' and ‘collective security' works together to deliver the prospect of higher median retirement incomes, largely because of lower volatility.

I personally also attribute this anticipated uplift to the unshackling of the pensions contract from the rigorous guarantee which annuities must deliver. This frees up CDC schemes to invest in a much wider range of higher return assets than annuity providers are allowed to. They can tap into illiquid infrastructure-linked investments for example - potentially helpful for the government as it sets itself on a path of ‘building back better' post-pandemic.

With some downside risk

However, with the prospect of access to those higher returns and increasing income if underlying investments have done well, also comes the downside risk that your CDC-based retirement income could fall if markets are turning against your underlying investments and/or more people are drawing on the collective pool than actuaries predicted would be at a particular point in time.

Here too there is a veiled positive for CDCs. Because retirement income from CDCs can also go down, The Pensions Regulator can operate a much lighter reserving requirement than the Prudential Regulation Authority demands of annuity scheme operators, which simply means that less of the investment return goes to insurance company shareholders and more to pensioners themselves.

Flexibility more in tune with our times

All things considered, the GAD and RSA predictions cannot be ignored. And if the going gets really tough and you need access to a lump sum in short order that may be possible with CDCs. Surrender values from CDC work on a ‘share of the fund' basis, and in retirement will factor in an up-to-date medical report. Before they start retirement, CDC members have a statutory right to transfer. But once they start to take the pension, the availability of a transfer benefit will be at the trustees' discretion.

So, for those looking for a half-way house where they don't have to decide how much retirement income to take (i.e., income drawdown) and worry about taking too much out, too quickly; and also don't want to be tied into a fixed, but not necessarily bountiful, guaranteed retirement income (i.e. annuities); then CDC-based decumulation may well be your best option, if indeed that option is extended to all DC policy holders which really it ought to be in the fullness of time.

As with all new choices in decumulation, especially those like CDCs which appear to offer such high hopes for individuals looking to optimise their retirement income without taking crazy risks with their savings, it's always going to be worth consulting a financial adviser.

It's important, for example, to remember that although the total pay-out from an annuity is expected to be lower, it comes with a cast iron guarantee. Not only are insurance companies very financially strong but the FSCS stands fully behind annuities in the unlikely event that an insurer might fail.

Advice opportunity

Finally, advisers have the capability to cut through the marketing hype to look at individual client circumstances to see who can and who cannot afford to be exposed to the risk of their monthly retirement income not increasing as much as prices, or in a worst-case scenario, even decreasing for a period. Nevertheless, as things stand CDCs look set to offer that happy trade-off between risk and reward to deliver the potential of higher retirement incomes for many more of us in the future.

Adrian Boulding is director of retirement strategy at Dunstan Thomas

[paulus103]

Something I actually understand :)

Thanks