Collective Defined Contribution (CDC) schemes are close to being a reality in the UK. On 16 December 2021, the DWP laid the regulations before Parliament that provide for CDC schemes, and specifically for the new Royal Mail CDC scheme, to open for business this summer.
Royal Mail is an ideal testing ground for CDC with its scale and tenure of service. But not many other private-sector schemes share these attributes and that is why, perhaps, the bigger opportunity here is not large, single-employer schemes like Royal Mail, but CDC used specifically for decumulation from DC funds.
Decumulation is not currently working well in the UK. The options are polarised. There is a growing advice gap. Taking members on a journey from no engagement to being able to design their own retirement income strategy is a Herculean task. The excellent free guidance service provided by Pension Wise is, sadly, little used. Many retirees are over-withdrawing, taking cash they don’t need and paying unnecessary tax. There is much inertia, and innovation to provide for better outcomes is difficult.
Robo advice, structured defaults, guided retirement choices and blended solutions are all ways that trustees and providers can help to provide better decumulation outcomes. At-retirement CDC is an emerging and promising addition to this list. It offers the prospect of a retirement income that maximises the income utility of the fund and does not run out.
At its simplest, the member commits their funds to the at-retirement CDC pool at the point they want to take income. A ‘target’ level of income is calculated, based on the size of the fund, their age and health, and the level of returns the fund expects. Funds are invested collectively for maximum efficiency and the income target is re-evaluated regularly considering the long-term investment and longevity experience of the pool.
So why should we consider it? Simple: more income. The CDC pool stands to offer more income than an annuity and a greater sustainable, regular income than drawdown. Analysis from WTW, reproduced in the November 2020 edition of Corporate Adviser, showed an at-retirement CDC pool providing over 50 per cent more potential retirement income than a sustainable withdrawal rate from individual drawdown and 49 per cent more than an equivalent annuity.
It does this in two ways. First, by providing a target level of income rather than a guarantee, it allows for an investment strategy with a higher allocation to growth assets, which gives the potential for everyone in the CDC pool to benefit from higher long-term investment returns.
The second is through longevity pooling. Committing funds to an at-retirement CDC pool, where a lifetime income is provided but there is no return of fund on death, means the CDC pool members insure each other against the risk of outliving their income. The mortality (or rather survival) credits that represent the re-distributions across the pool from those who die to those who survive contribute a significant proportion to the return, especially as members age.
In essence this comes down to members and trustees accepting different trade-offs. An income that can fluctuate instead of a guaranteed one. Using your DC pension pot for a lifetime income rather than ad hoc lump sums. Accepting that if you die ‘before your time’ you might lose out compared to someone who lives well beyond their life expectancy. And these trade-offs seem particularly attuned to many in Generation X who fall into the gap between the decline of DB and build-up of significant auto-enrolment funds and who need more regular income to cover basic needs and have limited accumulated funds.
New trade-offs can be scary and act as a brake on innovation. We do not have many years’ experience of explaining them to members, seeing how they respond and understanding the issues. This can make the risks and challenges appear more difficult than they are in practice. Someone prepared to take the first step is important and we do now have a working example to learn from in terms of the ‘QSuper Lifetime Pension’ plan launched last year in Australia.
Trustees need to be on the lookout for better decumulation solutions and at-retirement CDC merits serious consideration, particularly for consolidators and master trusts with scale. The pressure to gain more and more income out of every pound of fund is only going to grow and at-retirement CDC allows the pot to be squeezed that much harder.