Do CDCs offer the best of both?

26 Aug 2021

The DWP recently launched its consultation on draft collective defined contribution pensions scheme regulations, which is due to close on 31 August. Once these regulations are firmed up, by the end of this year in all probability, single or connected employers will be able to open collective defined contribution schemes for their employees. The Royal Mail, in a show of unity between employer and trades union, will be the first to do so.

We will have to wait until early 2022 before any further consultations to explore extending collective defined contributions availability more widely. But that is the prospect. So, it’s worth exploring the possibility that within the next few years, master trusts could be able to offer collective defined contribution decumulation widely to savers who have built up savings in other defined contribution pension schemes.

As this is a possibility within this timeframe, why would workplace advisers (for now) consider pointing pension savers in the direction of collective defined contributions at retirement? To answer that question, it’s important to understand the similarities and differences of collective defined contributions and annuities.

CDCs vs annuities

Collective defined contribution decumulation schemes, like annuities, will offer a regular monthly income in retirement for the entire life of the buyer. A collective defined contribution will also offer the prospect of that income increasing yearly in line with prices, thus preserving the pensioner’s standard of living. The expectation is for a substantially higher pay out over the duration of retirement.

A 2009 Government Actuary’s Department study found that the median improvement in outcome offered by collective defined contribution “is as high as 39% for some members.” A 2012 paper by the Royal Society of Arts indicated a 37% boost to retirement income outcomes through collective defined contribution.

I attribute this uplift to unshackling the contract from the rigorous guarantee offered by annuities. This frees up the collective defined contribution scheme to invest in a wider range of higher return assets than annuity providers are allowed to – maybe even some of the ‘Big Bang’ assets the prime minister and chancellor advocated in their recent Open Letter, the rich pool of assets ripe for long-term investment and bolstered by British entrepreneurial spirit.

And because collective defined contribution pensions can go also down, TPR can operate a much lighter reserving requirement than the PRA, which simply means that less of the investment return goes to insurance company shareholders and more goes to pensioners themselves.

Yet it’s precisely because collective defined contribution is accompanied by such high hopes that individuals really will benefit from taking advice. 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.

Advisers have the capability to cut through the marketing hype and look at individual client circumstances to see who can and who cannot afford to be exposed to the risk of their monthly income not increasing as much as prices (or in a worst case, even decreasing year on year). Collective defined contributions could offer that happy trade-off between risk and reward to deliver the potential of higher retirement incomes for more of us.

by Adrian Boulding, Director of Retirement Strategy at Dunstan Thomas.
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