In spite of Gordon Brown ‘simplifying’ pensions in 2006, we have yet more changes to digest!

Previously in the UK, we have had two main types of pensions

• Defined benefit (DB) – also known as final salary, that pays a promised pension based on salary and length of service. The employer guarantees the promised benefits are paid and for that reason, you don’t come across them very often, usually only schemes backed by the government in some way or another.
• Defined contribution (DC) that doesn’t provide any guarantees and instead provides a pot of money. The value of the pension pot will go up or down, depending on investment performance, costs and how much you’ve paid in.

Almost certainly, if you had a DB scheme you are significantly better off in retirement than someone with a DC scheme (everything else being equal), whether you are drawing from that scheme or you have transferred it away into a DC, the differences between the two are mind-blowing.

Now, in the Pensions Act 2021, a third type is being introduced called ‘Collective Defined Contribution’ (CDC) schemes.

In a CDC scheme, both the employer and employee contribute to a collective fund aiming to pay an income in retirement. Unlike in a defined benefit scheme the employer does not need to guarantee the benefits paid by the scheme. CDC scheme aims to provide a target income but if the scheme is under, or over-funded then the pensions it pays can be changed accordingly.

Potential advantages are claimed as:

For you, the member:

• Retirement in one simple place: Members of CDC scheme can both build up a pot (accumulate) and receive an income (decumulate) via the same scheme. This has similarities to how a DB scheme works, although the income is not guaranteed, probably the most important part of a DB scheme.
• Longevity risk sharing: In DC schemes members hold individual pension pots. Because nobody knows how long they will live there is a risk that people underspend (dying with unused funds) or overspend (running out of money). CDC schemes claim to manage risk collectively by paying pensions based on average life expectancy across the scheme.
• Investments: it is argued that CDC schemes can take longer-term investment strategies than DC because they have a mix of members in accumulation and decumulation.

For your employer:

• CDC schemes will be attractive to employers by allowing them to offer employees a pension scheme, with an estimated income in retirement, but without any risk that they will need to pay anything if they cannot afford to pay that income.
• An income without a risk premium: As CDC schemes do not guarantee an income, there is no additional cost to secure that guarantee.

The main disadvantages of CDC schemes are seen as:

‘Target’ income: Benefits in CDC schemes are not guaranteed which means that the pensions paid out can fall. So, it’s just a projection based on certain factors, like a DC scheme really.

Complication: CDC schemes are seen as more difficult to explain than defined benefit schemes (which pay a promised benefit) or defined contribution schemes (in which a saver builds up a pension pot which they can decide what to do with).

Some members and their families will be worse off: A consequence of longevity risk sharing is that some members must be worse off than if they would have been in an individual defined contribution scheme, where those who die younger subsidise the pensions of those who live longer. Therefore,

Transfers: Those people mentioned above will likely want to transfer out of a CDC scheme and receive a proportion of the collective fund. There is a big risk that if members with lower life expectancies are transferred out of a CDC scheme with the full value of their share, then the advantages of longevity risk sharing are lost.

Intergenerational fairness: As with the state pension system, where young people are now being asked to work for longer and longer to subsidise the shortfall in the state pension, unfairness will occur if one generation’s funds are used to subsidise another one.

Opinion:

Pensions should be amazing and have loads of benefits not always understood by anyone outside our ‘pensions nerd club’, because they are way too complicated and none of us likes to feel confused. That, plus a boring image means pensions are way too underused in financial planning and definitely have become the poor cousin of simply buying more and more rental properties, then weirdly moaning local kids can’t afford to buy houses. Adding in another regime, I think complicates things further- which is bad – and I don’t think adds any benefit to anyone who is getting some decent pensions advice already. The other main way to share ‘longevity risk’ were annuities, which the government in 2015 removed as compulsory for pensions as they offered such poor value and inflexibility, I can’t see how this will be any different.  A CDC scheme might only be of use to those who don’t take retirement planning that seriously (for whatever reasons, good or bad ones) and really don’t want to get involved or plan. Other than that, I cannot see any benefit in a CDC over owning your own ringfenced personal pension, which you can now either empty (by spending) or hand down (by not spending) to your family or whoever you choose in a tax efficient manner. There are many ways to get advice on pensions but we would recommend avoiding online with all the potential scams and checking out a fully regulated (by checking on www.fca.org.uk), independent and preferably chartered firm of financial planners.

To find out more about your pension options, contact us today at hello@ssfs.co.uk