The RSA has launched a cross-industry Forum to support the implementation of Collective Defined Contribution pensions. But what are these pensions? And how can they benefit workers across the economy?
A system in pieces
When people are asked about what they want from a pension, many will tell you something along the lines of “a predictable income, from the time you retire, until the time you die”.
However, in 2018, this is out of reach for many people. Most people in the private sector are in Defined Contribution (DC) schemes, where funds are invested in an individual account that can be accessed upon retirement. This can then be used to buy an annuity, an insurance product, which typically pays out a fixed sum of money each year for the rest of their life. However, in recent years, annuity rates have dramatically declined. These products are now very expensive and don’t offer value for money. In 2003, a pension pot worth £100,000 would have translated into an annuity worth £7,300. Today it will get you closer to £5,500 – 25% less.
In 2015, the Government introduced a set of pensions freedoms that encourage an approach to de-accumulation known as drawdown. People can take up to 25% of their pension tax free upon retirement and then carefully drawdown their remaining funds. At the time, fears were raised that this would lead people to irresponsibly splurge and buy that Lamborghini they always dreamed of. Withdrawal figures since suggest this has not quite panned out. But broader concerns remain. Genetics is not yet sophisticated enough to predict when we are going to die. So how can people be sure that they will not run out of money before then?
Meanwhile, Defined Benefit (DB) schemes are becoming increasingly unsustainable. These schemes do offer a guaranteed income in retirement, often pegged to final or average salary and inflation-proofed. Hence why they are often perceived as ‘gold plated’ by millennials like myself. However, for many employers they are no longer affordable. In part, due to a changing landscape of business models, and increased pressures from the likes of Amazon in retail and Hermes in logistics.
Critically, the success or failure of DB schemes is tied to the employer. And as recent high-profile closures at Tata Steel and BHS remind us, if these schemes do collapse, workers can be left with a raw deal.
CDCs – a happy medium
Commonplace in Canada and the Netherlands, Collective Defined Contribution (CDC) schemes provide a third option.
CDC schemes allow ‘longevity risk’ to be pooled between workers, by giving them an option of paying into one giant pot with other people from the company they have a pension with. This means that those who die younger help to pay for others, but all are ensured an income until the day they die. These schemes benefit from economies of scale (e.g. lower fund management costs) and can make longer term, mixed-risk investments. As a result, they offer workers a much better deal than using a DC fund to buy an annuity. Studies by RSA and Aon Hewitt show that for the same contributions, CDCs can deliver 30% higher pension payments.
Unlike DB schemes, there is no strict guarantee from the employer. Indeed, CDC schemes can be managed by a third-party provider such as an insurer. Instead of a fixed benefit, that increases each year in line with inflation, CDCs aim to deliver a target benefit – a defined ambition. This can vary from time to time, sometimes increasing by less or more than inflation. In Holland, where forms of CDC are common, pensions in payment were actually reduced (by about 2%) following the global financial crisis. But this flexibility helps CDCs weather economic shocks, ensuring that they remain sustainable, come hell or high water.
Introducing the CDC Forum
The 2015 Pensions Schemes Act gave the government powers to allow for CDC and similar pensions. But the secondary legislation to create them was never introduced. The view was taken that the market – an employer – needed to first express demand.
The Royal Mail and the Communication Workers Union (CWU) have since committed to introducing the UK’s first CDC scheme. As one roundtable attendee pointed out, “there has never been a situation where a company and union are so committed – there is clearly a genuine willingness to take this forward in the interest of employees, union and employer”.
And across the political spectrum, there is a desire to make this a reality. The Pensions Minister Guy Opperman has been working closely with the Shadow Minister Joe Dromey to facilitate the necessary legislation while the Labour Frontbench has given its wholehearted support.
The RSA is convening the CDC Forum, to support the policy debate and ensure we take this opportunity to benefit savers, through developing an effective regulatory framework and appropriate governance model. Supported by Royal Mail and CWU, the CDC Forum will host a series of events and publications to develop this work and welcomes the consultation on implementing CDC that the Government is due to open.
The clock is ticking. In the short to medium term, our focus is on CDC as an alternative to unsustainable DB schemes. To benefit the 142,000 people who work for Royal Mail. And provide a model that could be adopted by other large businesses, which may be under strain because of an economy in transition.
In the future, there is scope to develop CDCs as an alternative to DC, where people may have previously opted for an annuity. The broader financial inclusion argument here cannot be understated – CDC could boost the economic security of the millions of people in the UK currently enrolled in DC schemes. The 2017 auto-enrolment review suggested that around 12 million individuals are under-saving for retirement. CDC would help address this by enabling smaller pots to go further in terms of the retirement income they can generate.
And thinking about emerging forms of employment, these schemes may provide an answer to the lack of pension provision for people who are self-employed or using online platforms in the gig economy. As our recent Venturing to Retire report showed, it is these workers who are often the least well prepared. As CDC schemes don’t depend on employers, there is potential scope for independent workers to pool together via industry, trade union or app, and enjoy the benefits of collective investment.
Read our latest briefing paper.