A new breed of pension scheme known as a Collective Defined Contribution Scheme (or Collective Money Purchase) may commence in the UK from 2021. It is an alternative to both Defined Benefit and Defined Contribution schemes. The Pensions Schemes Bill 2019/20 includes provisions to allow the scheme to open in the UK from 2021, initially the schemes will be set up under trust, with single or associated employers able to establish their own trusts.
What is Collective Defined Contribution (CDC) Pension Scheme?
A CDC scheme is a pension scheme where the employer pays a fixed rate of contributions, similar to a Defined Contribution scheme. In a CDC, the employees receive pensions with variable increases through cross funding within the scheme between members of the scheme.
It is expected that the CDC scheme can provide higher pensions levels for employees than a traditional Defined Contribution arrangement where an annuity is purchased.
A CDC scheme aims to achieve higher levels of investment return by sharing the risk between member employees over time. These ‘risk-sharing’ plans are already available in some other countries including Canada and the Netherlands. Compared with buying an annuity with an insurer, a CDC scheme is expected to achieve a 70% higher pension than an annuity purchase, although this is not guaranteed.
It is suspected that actuarial advice will need to be reasonably prudent so that expectations are not overplayed, so it remains to be seen how heavily CDC schemes will be invested in high risk assets. The trustees will need to ensure fairness and maintain that there cannot be one group of members continually subsidising another group.
What are the advantages of a Collective Defined Contribution Pension Scheme?
The theoretical advantages for employers are:
- Pension contributions payable are fixed so there is cost-certainty for the employer – unlike Defined Benefit pensions.
- Members receive a set pension, so should not run the risk of running out of money unlike an Individual Defined Contribution (IDC) pot.
- There is no need for members to make investment decisions like an IDC plan
- Pension levels are expected to be higher for members than an insured annuity through an IDC account.
- Pension levels are designed to be smooth rather than volatile with gradual adjustments to the rate of pensions increases.
What are the possible downsides I should be aware of?
- If contributions are fixed and there is poor investment return, pension levels will need to drop which could lead to volatility.
- Pension freedoms and drawing down pension savings will not be available to those in a CDC scheme and some members may prefer having more freedom of choice.
- In order to maintain pension levels for one group of members, other members could lose out. This will be a challenge for trustees to ensure fairness.
- Pension levels could potentially go down like an IDC plan.
The performance of CDC pension schemes may well depend on how global stock markets perform in the future. Abbiss Cadres assists UK and international clients, as well as other advisers, on all aspects of UK pension law. For more information on Collective Defined Contribution pension schemes or if you’re considering introducing this to your organisation, please get in touch to speak to our experts.