Alongside a Pensions Tax Bill that will give people much more freedom over how they access defined contribution pension savings, today’s Queen’s Speech contains a Private Pensions Bill that paves the way for ’Collective Defined Contribution’ schemes, where risks are shared between members. Target pensions could be improved or cut back depending on the funding position of these schemes. Commenting on the government’s reforms, Will Aitken, senior DC consultant at Towers Watson said:

The point of ‘Collective Defined Contribution’ is more stable outcomes, not bigger pensions

“Collective Defined Contribution (CDC) is sometimes presented as a magic wand that can make everyone better off in retirement but the government has never been convinced of that. Instead, it hopes that CDC can make pensions less of a lottery, rather than making them bigger on average. That’s a worthwhile aim, but CDC will only succeed if people trust the black box that adjusts the value of their savings up or down. Unless employers believe they will, they won’t set up CDC schemes.

“Claims that CDC can make everyone richer are based on the idea that pensioners’ savings could stay invested in equities rather than being used to buy annuities. But pensioners can do that anyway, especially since the Budget. The difference with CDC is that younger savers must ride to the rescue when markets disappoint, while some of the upside is kept back from pensioners when things go well.  It’s easy for either side to conclude that they are not being treated fairly, particularly in a prolonged bull or bear market, making pensions an intergenerational battlefield.

“Now that members of DC schemes have more alternatives to buying annuities, more may choose to hold assets such as equities for longer in the hope of generating a higher return.  The riskiness of investments could be gradually reduced as people draw down their pensions, rather than in the run-up to retirement. If CDC would improves outcomes, so would this – but retirees would have to decide whether they are happy to take more risk without intergenerational transfers fall back on.”

Crucial details awaited

Piggy Bank © The Economic Voice“Most of the legwork on CDC was done before the Budget, and may have to be rethought. Most obviously, will CDC schemes still target an income in retirement rather than a capital sum at retirement?

“Portability and individual control were at the heart of the Budget reforms, but are called into question with CDC.

“You can allow people to transfer out of a CDC fund, but that is likely to mean adjusting the value of their savings first. How this is done must be transparent and could prove controversial. It’s also unclear whether starting to receive a CDC retirement income will be a big one-off decision that you cannot reverse, like buying an annuity. If retirees can cash out their CDC pensions at any point, that could play havoc with the longevity risk-sharing they are meant to provide.

“Employers are already starting to think through how they will change their pension offerings in 2016, when State Pension reforms will make defined benefit schemes more expensive to keep going on current terms. If reliable details of the CDC regime are not available soon, they may come too late. We doubt that CDC will be to most employers’ taste given the intergenerational equity issues, but it should be on the menu.

“It is often taken for granted that CDC schemes will benefit from economies of scale, but using the word ‘collective’ doesn’t make a scheme big.  In other countries, CDC schemes have got big quickly by converting existing defined benefit pensions without members’ consent. That won’t happen in the UK.”

The fate of ‘DB light’

“It looks as though the Government has abandoned plans to preserve a slither of defined benefit pension provision in the private sector by giving employers more choice over what benefits they promise in future.  We’re disappointed by this – employers who are prepared to take some risk off employees’ shoulders should not have obstacles put in their way.

However, there are already lots of things that employers can do to reduce costs and risks if they don’t want to close their schemes altogether.”

Capping charges in the new legislative framework

“In creating new categories of pension scheme, the Government has also created exemptions to its cap on charges. Charges would not be capped where savers pay insurers to provide guarantees, nor in CDC schemes where members make promises to each other. It’s not obvious why these are always better value ways of managing risk than investment strategies that will still be subject to the charge cap such as a diversified portfolio of different return-seeking assets.”

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