The topic of collective defined contribution (CDC) pensions, a model widely used by the Dutch, has been much debated in recent months. The Budget announcement makes this is the right time to highlight how it differs from DC. As a company with strong connections with the Netherlands, Aegon UK is uniquely placed to understand the differences between the two models, and what it might mean for UK consumers if the former was to be adopted.
Dutch CDC models offer the benefits of scale. They are collective investments that remove the need for individuals to de-risk in the lead up to retirement, instead allowing investment in growth assets for longer. Retirement income is normally paid directly from the scheme in a shape, and from an age, set by the employer, trustees or pension provider. Some commentators have claimed that retirement incomes under CDC could be more than 20 per cent greater than under traditional DC, such as those offered in the UK due to the collective nature. While it is possible this may be the case, it is by no means guaranteed, and comes at a price that is worthy of further debate.
Under the Dutch model the focus is the collective group and the possibility of inter-generational transfer is widely accepted and, to some degree, expected. In the UK, we were already increasingly moving towards individual retirement income solutions, tailored to the individual’s needs and circumstances. This could include consolidating pension pots, deferring retirement, buying an annuity, drawing down income, or possibly even a combination of all of these. The Budget announcements accelerate this sharply with individuals in future having complete flexibility. So the key difference between CDC and the UK DC model is that here we have flexibility and choice in how and when we take our retirement income.
With the CDC model retirement flexibility simply isn’t an option. Retirement age and the shape of the retirement income are fixed when the member first joins, which could be 10, 20 or 30 years before retirement. In the Netherlands, there isn’t even an open market option and retirement incomes are not adjusted to reflect the health and life expectancy of the policyholder. Nor is there the option of phased retirement, which is becoming increasingly common in the UK, where people draw down a portion of their retirement income in order to supplement reduced earned income, enabling reduced hours or a change in career.
In addition, in Dutch CDC, mechanisms are in place to protect the risk of inter-generational transfer by retaining scale. And this means limiting or controlling payments made out of CDCs. The right to a transfer value is very limited; members can only transfer out within six months of leaving their employer, and this means pension consolidation, isn’t an option. And Dutch members don’t have the choice of cashing in their pension pot at retirement – an option the UK population will have from April 2015.
In the UK, tailoring a retirement income to best meet peoples’ needs and circumstances can be complex. Advice or guidance is needed to help people get the most from their pensions’ and savings, whether they are buying an annuity or taking other options. The Dutch CDC model lacks flexibility and seems to go against consumer trends and the reforms outlined in the budget. It’s possible some of the Dutch CDC features could be adopted in the UK, but it would need very careful analysis.