Dutch-style retirement plans could boost retirement income by 7% a year
It’s probably the holy grail of governments around the world – how to increase individuals’ pension incomes without necessarily increasing the amount they need to contribute.
Much depends, of course, on the nature of the pension scheme into which individuals are saving – and a range of different schemes are currently in operation in various countries.
So-called Collective Defined Contribution (CDC) schemes used in both Holland and Denmark have caught UK government ministers’ eyes and the current Minister of Work and Pensions, Amber Rudd, has told parliament that this country might have a lot to learn from them, according to a story published in the Express newspaper.
The Commons Work and Pensions committee said that analysis had found the CDC schemes can offer more predictable benefits than individual defined contribution provisions, as well as savers being better off by up to 7% a year.
This new type of scheme is being pioneered in the UK by Royal Mail and could eventually be opened up to allow schemes to be set up across a number of employers.
How do Collective Defined Contribution (CDC) schemes work?
The secret to a successful pension scheme lies in encouraging savers to invest in it. For it to be sufficiently attractive, it needs to pay well in terms of the contributions made by employees, without imposing undue costs on employers, so giving some degree of stability and flexibility in the management and eventual use of the accrued pension pot.
In an article on the 18th of March 2019, iNews described CDC schemes as a kind of halfway house between the existing Defined Benefits (DB) and Defined Contribution (DC) pension schemes in use throughout the UK:
- otherwise known as workplace pensions or final salary schemes, these are pensions that pay out an agreed percentage of the individual's final salary immediately before their retirement, regardless of how much they may have contributed while at work;
- with a high level of certainty on the pension to be received, such schemes are highly prized by employees – a guaranteed pension remains in payment, therefore, for as long as you live;
- for the same reason that they are highly prized, however, defined benefit pension schemes prove very expensive for employers, who have responded by steadily withdrawing their availability in recent years – the majority of these schemes are now closed;
- defined contribution (DC) schemes have almost wholly superseded defined benefit schemes;
- in these schemes, both the employee and the employer contribute to a pension scheme to create a “pension pot”, which is invested by a pension provider;
- when you retire, the current value of that pension pot is then available for you to buy a lifetime’s income (an annuity) or to draw down sums of cash as and when you need them;
- although defined contribution schemes are typically more flexible than final pension schemes from the employee’s point of view – and cheaper from the employer’s – the major drawback is that the uncertainties of the stock market mean that the value of your final pension pot depends entirely on those investments the pension provider has chosen to make;
- unlike a defined benefit pension, there is no income for life – just your finite pension pot, so you need to manage the funds very carefully to avoid running out of the money you need in later life;
Collective Defined Contributions
- CDC schemes still give you a finite pension pot on retirement, but one that continues to pay out for as long as you live;
- when you pay into this type of scheme, you have a broad indication of how much your pension is likely to be worth when you retire, since the ups and downs of the stock market are effectively smoothed out through the collective performance of the market, rather than the individual investments made by the providers of defined contribution schemes;
- employers have a degree of certainty about the cost of the scheme (the contributions that need to be made) and employees enjoy greater stability from the markets – and, therefore, the value of their pensions.
Collective Defined Contribution schemes have previously been considered in Britain before
The concept of Collective Defined Contribution (CDC) schemes – which have worked successfully in the Netherlands and Denmark – have been under serious consideration by British governments for some time. As early as 2014, for instance, the idea was included in the pensions bill which ultimately scrapped the compulsory purchase of annuities and CDCs received broad cross-party support, said the Guardian newspaper on the 4th of June 2014.
In February 2018, FT Adviser also described the benefits of CDC schemes as effectively “squaring the circle” between expensive DB schemes beloved by employees and the DC schemes favoured by employees because of the certainty of the costs involved.
A CDC scheme is based on a trust structure in which trustees act on behalf of the members (those saving for their pensions) by making investment decisions on which pensions for life can be paid to members from the pooled or collective investment, taking into account the actuarily calculated length of the lives of the members.
But this is also achieved by restricting employers' responsibilities only for paying the contributions originally agreed for the scheme and not asking them to assume any of the obvious risks of the scheme having set unrealistic or over-optimistic outcomes from the collective investments made.
With all the negativity in recent years about company pensions, it is good to see this innovation in the industry to provide stable - and potentially more fruitful - provision for people in later life.