Margaret Thatcher once claimed that “There is no such thing as society: there are individual men and women, and there are families”. Since then the collectivism of defined benefit (DB) pension schemes and annuity purchase has been replaced by defined contribution (DC) pensions and drawdown. Collective defined contribution (CDC) is the government’s attempt to reintroduce risk sharing, or collectivism and cross subsidy, depending on your point of view.
I am keen to make clear that we support the government’s decision to allow CDC schemes to be developed as they do have the potential to deliver good retirement outcomes. But there is a lot that needs to be considered before we dive head first into this new form of
pension saving.
Both proponents and opponents of CDC are keen to point out the need to describe the scheme as a DC scheme, but there is a danger in doing this.
CDC schemes incorporate similar cross subsidies to DB schemes. Put simply, employers and employees each pay a fixed percentage of pay into a CDC scheme. In return they receive a promise of a percentage of pay in retirement for each year they are a member.
Two people earning the same amount, one aged 20 and one aged 60 would have the same amount paid into the scheme, and accrue the same pension promise, payable from the same retirement age. It all seems fair. But the promised pension to the 60-year-old needs to be provided a whole lot sooner than our 20-year- old’s promise, so our 60-year-old needs a bigger slice of the contribution pie than their younger colleague. There is less time for investment performance to contribute to the cost of the 60-year-old’s promise.
That is why I think it makes sense to communicate CDC benefits in the same way as DB and concentrate on the pension promise, rather than the contributions. To say each employee accrues a promise of percentage of salary per annum sounds fair.
Referring to the level of contributions creates issues, as does the disclosure of charges and the effect of charges illustrations demanded from DC schemes. CDC members have an entitlement to a transfer value rather than a pot built up by contributions. If we tell our 20-year-old and our 60-year-old that the amount that has been paid in is the same, they might expect the same transfer value if they leave – but the 60-year-old will get a lot more. The transfer value will be based on the value of the benefits promised, not the amount paid in, and the value of a promise to be paid in 7 years’ time is a lot more than one to be paid in 47 years’ time. It serves no purpose to focus on contributions, fund values and charges, other than to highlight the inequity of CDC when it comes to the value of the benefit provided each year.
Of course, younger members will reap the benefit of cross subsidy when they get older, assuming they are still with an employer providing a CDC scheme. In a job for life, pre-Thatcherite world that might have rung true, but with an average of 11 jobs in a lifetime many youngsters will only experience the downside of cross subsidy. We must make sure CDC schemes are generous enough to provide every member with at leastthe same benefit as they’d accrue in an automatic- enrolment DC scheme.
When it comes to retirement, the double- edged sword of cross subsidy comes into play once more, contrasting with the DC world of choice. Even where there is cross subsidy in DC, within the annuity market, health questionnaires ensure a fairer share for those in ill health. While drawdown represents the ultimate expression of individualism.
Older workers will do well out of CDC and those with greatest prospect of a long retirement will do best out of a CDC scheme pension. A fit and healthy woman, living in leafy Surrey would do well to consider CDC. So long as she wants an income for life and can accept the risk of her income falling.