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CDC schemes – a new pensions world?

CDC schemes – a new pensions world?

Category: Pensions

This article was correct at the time of publication. It is now over 6 months old so the content may be out of date.

Yesterday the Queen gave her annual speech at the opening of Parliament, informing the nation of what ministers would be concentrating on in the final year before the next general election. While 11 new bills were covered, the key – at least for a lot of commentators – was the focus on pensions. CDC pensions in particular.

Collective defined contribution, or CDC, pension schemes are essentially a form of collective saving where members of the scheme pool their money into one collective pot, rather than saving into their own. The pension scheme itself will pay out an income in retirement, the amount being determined each year by specialists, which means there'll be no need to buy an annuity.

It's a big change from the current form of defined contribution. As it stands the schemes are run on an individual basis with the value of the pension being solely determined by the contributions (and subsequent returns) a saver makes – and they're then free to use that pot as they wish – but the proposed move to collective schemes means savers could potentially be paying into a fund with thousands of other workers.

This "collective" format, argue advocates, will spread the risk and reduce investment volatility, and because all contributions will be pooled into one fund the administration costs will be lower – and, ideally, it could lead to a better retirement income.

It's a system that has been adopted elsewhere, namely in places such as the Netherlands – which is why these schemes are widely referred to as "Dutch-style" pensions – and could be introduced as soon as 2016. Ministers have said this kind of system will offer savers better value and could potentially offer more stability and certainty over pension outcomes, however not everyone is convinced.

Critics of the scheme argue that, because the risk is shared collectively, it's also transferred between generations – meaning some cohorts of savers could lose out.

The scheme uses extra investment returns when a fund performs well to make up for the lower returns achieved when it doesn't, so for example, if a fund performs badly it won't affect those who are close to taking their retirement income, but it will have an impact on those who are still saving as their returns will be needed to bolster the pension pots of older workers – and they could end up with a lower income than if they were saving individually.

Unlike an annuity there's also no guarantee of a set retirement income, just a target, so if investments fail to generate the necessary profits the resulting pension incomes could be cut.

Nonetheless, there's political support for the scheme from all sides, so if the bill is passed all employers could eventually have the option of enrolling their workers in this kind of scheme.

Tim Leonard, pensions expert at Moneyfacts, commented on the announcement: "The Government's attempts to provide better retirement incomes for pension savers are admirable, but CDCs will not be for everyone. Pooling risk and lowering administration costs are certainly big advantages of such schemes, but at the same time, the individual ultimately has less control over their own retirement outcome.

"Given the pension reforms announced in the Budget were all about giving retirees greater flexibility in terms of what they can do with their pension pot, introducing this option into the mix could ultimately end up confusing people. Even if the schemes are eventually introduced, this is at least two years away. In the meantime, the best thing people can do is to start saving into a pension as soon as possible."

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