What is it?
CDC comes from a Dutch and Canadian initiative and will allow pension funds to be run collectively as opposed to individually. It is hoped that this will help keep costs down and therefore profits (and pensioners’ incomes) up. The changes are not expected to become law until 2016 and are one of many changes to pensions the Government has been looking at in recent years.
How will this work?
Workers and employers will pay their contributions into one pot, rather than an individual pension plans. This will contain contributions from tens of thousands of others, which will then be invested in stocks and shares.
When someone reaches retirement, the insurance company running the scheme will work out how much income they have every month, based on factors such as:
- Age
- How much they've contributed to the pot over their career
- How well the invested pots have performed
Therefore, rather than the success of an individual pension pot being dependant only a handful of investments, the collective pot is designed to ‘spread the risk’ across a wider range of investments, hopefully giving the opportunity for larger growth yet mitigating losses during tricky times.
How does it compare with current schemes?
Currently many employees are on a ‘defined contribution scheme’. This type of pension plan will have a degree of uncertainty on what savers will receive on retirement. Most then need to buy an annuity on retirement to give them a certain income.
Other, luckier employees are on ‘defined benefits’ schemes, which include final salary schemes. These give workers a guaranteed income in retirement based on their working record, but can be expensive for employers who have to meet the promised amounts.
It is hoped that the new collective scheme will fall somewhere between the two. It will pay out an income on retirement so no annuity is needed. The level of income each year will be decided by actuaries who will aim to achieve a particular level of income.
What are the criticisms?
It is hoped that the new collective scheme will be better than the current defined contribution one but, of course, this cannot be guaranteed and more research is needed.
Some critics have pointed out that an annuity will provide for a guaranteed income while the collective scheme will provide only a ‘target’. The same age-old issue still remains: investments might fail and pensioners could see a drop in their income as a result.
It’s also important to remember that because funds are shared by people of all ages, there is the possibility of inter-generational conflict. There have been recent complaints in Holland that savings from younger workers are being used to subsidise the retirement incomes of the elders. In fact, people in the Netherlands have been calling for a move to a similar system to the UK, following a period of poor performance by collective schemes.
Summary
What is clear is savers of differing ages, income levels and financial commitments will have different priorities so while one person may feel they will benefit from having their retirement pot collected in a group, another might not.
With so much debate and uncertainty surrounding pensions in recent months what must be certain is there is no one-size-fits-all solution. Workers should undertake their own research, determine what best fits with their personal circumstances and perhaps try not to put all their financial eggs in one pension basket.
Laura Milne is founder and managing director of consultancy LIME hr
