There will be a new choice for those who want control of how they spend their retirement savings.
The choice will be a Collective Defined Contribution (CDC) Scheme. CDCs offer a target pension which we reckon will deliver a predictable lifetime income without the guarantees from an insurance company or an employer.
Employers can set up these schemes , asset managers and benefit consultants can set up these schemes, insurers and master trusts like NEST, NOW will almost certainly set up these schemes.
But why are they needed?
The annuity changes announced in the budget will allow people to choose how they want the pots they accumulate over their lifetime to be paid back to them as they want.
Some people will choose to take their cash and spend it, some will set up their own investment portfolios and have the money managed by someone they choose (which might be themselves).
But the vast majority of people do not want to manage their money. They want an income in retirement that is paid to them according to their needs.But they do not want to manage the money in the meantime.
CDC schemes are there for this group of people. Nearly 90% of all pension savers use the default investment option offered to them. We do not know that as many will choose a default investment option for their money in retirement (we think not), but we believe that the behaviours of people don’t change radically, just because they’ve started drawing on their pension savings.
We think that well over half of all those drawing their DC pots will use these kind of schemes.
There is nothing very new about CDC schemes . They will actually work as a cross between defined benefit and defined contribution schemes and to people using them, they will feel like company pensions.
With one important difference!
When you are saving into a pension plan these days, your employer is (or soon will be) required to pay in to your plan as well – this is known as “sponsoring”.
Currently, for a plan to be set up to pay pensions out, there must also be a sponsor, someone who will make sure that a defined benefit is paid to you month after month, till the day you die.
But this creates an impossible burden on employers. And employers are increasingly walking away from these obligations- closing their schemes to new hires and making sure they aren’t any more on the hook than they have to be by “closing schemes for future accrual”.
It’s the same for defined benefit and defined contributions
It’s long been recognised that paying a pension from a very big pot is much safer than doing it from an individual pot.
Infact until the budget reforms changed this , you needed around £250,000 to have any freedom not to have to buy an annuity (and to get real freedom you needed at least twice that).
But if employers tot up all the little pots of their employees , they can find they have quite large super-pots (Lloyds Banking Group for instance has well over £2bn of DC pots they manage for their staff).
For some large employers, it makes sense to offer these staff a collective defined contribution plan, not because they have to , but as an employee benefit.
But until today, that would have meant that the employer (the sponsor) would have had to have guaranteed the “monthly payments to death” through to retirement. This is because of a troublesome legal case surrounding the Bridge Trustees (which we needn’t go into because it doesn’t matter now).
Now a large employer can set up a collective scheme simply to pay out pensions for staff without being on the hook for markets and for people living too long.
Some large employers will want to do this and they’ll want to do it for the same reasons as they provide health insurance, income protection and (historically) defined benefits. They’ll do it because it is an employee benefit, because they can and because they recognise that it’s in their DNA.
But it’s not in the DNA of most smaller companies – let alone the micros and the self-employed! Nor is it in the DNA of those who set up Group Personal Pensions and master trusts. No one can afford to sponsor these arrangements if the price of sponsorship is to be on the hook for everything that goes wrong.
But this is not just for employees of large companies- everyone can participate
But this is where CDC works not just for large employers, but for those who currently run multi-employer schemes for small employers (and the self-employed)
As well as single employer CDC schemes , we will see schemes which anyone can tip their money into. Let me give you an analogy…
Imagine you grow grapes on the sunny hill-side in Umbria, in your local village there is a co-operative who will take your grapes and turn them into wine. You bring them grapes, they give you wine, and if you bring them lots of grapes, they promise to give you wine for the rest of your life.
This is how collective defined contribution schemes will usually work.
Substitute for “village” “provider”.
Your pension provider – L&G, NEST, NOW, Standard Life or whoever, will offer you the option to convert your pension savings into one of these collectives and offer to pay you back your money at a pre-defined rate.
That rate isn’t guaranteed – it is targeted (some people call these Target Pension Plans). Insurance companies and master trusts are no more prepared to guarantee people lifetime incomes from fully invested funds than large employers – but they very much want to provide pensions on a targeted basis.
How they manage these plans is up to them but – as with single employer schemes- these plans will be subject to tough rules, they will need top management, sound investment strategies and they will be under the utmost scrutiny from everyone from the Pensions Minister to the Pension Plowman!
Some of these plans may revert to an investment process similar to the old with-profits, some may use dynamic asset allocation, some may used structured products provided by banks. Some will work better than others.
We think it important that everyone has the choice to join one of these. We think that those who provide pensions on the way up, will be offering continuation options to manage your pot as you spend it. (see the graph above)
We also think some new pension providers will arrive simply to offer CDC for those in retirement.
You may favour one approach over another, you may want to take guidance as to the pros and cons or you may want to be advised as to which approach is best for you.
And for many people, a default continuation option from the provider they have saved with, will suit them fine. Provided there is a quality assurance attaching.
So you will have more choice- but also a simpler choice.
3. Standalone CDC Scheme
4. CDC scheme of your provider.
Frankly 3 and 4 will operate like the old annuity purchase system. Many people will stay with their provider, some people will think they can do better elsewhere (open market option)
Moving money from one scheme to another is not “free”, you sell out of one fund and buy into another and you trigger expenses which you’re going to have to pay from (within your fund).
But that said, the decision you take on what CDC scheme to use -need not be irreversible and unlike an annuity, you could switch from one CDC scheme to another.
So we have more choice- but one simple choice- to stay where we are (option four)
Why CDC makes long-term sense for this country
Dispensing with the guarantees, clubbing together to provide economies of scale, rationalising advice and pooling the risk of living too long, give Target Pension Plans the opportunity to boost pension pay outs by up to 50%.
This is recognised not just by the European pension systems that have adopted this approach but by our own Government Actuary who accepts that the cost of converting savings into income is about 60% that of buying an insurance annuity. If you don’t believe me , read this.
What’s more, CDC encourages long-term investment in businesses and help pension funds realign themselves as the providers of long-term capital to the key drivers of the British economy, our manufacturing and servicing industries.
For four years I have been blogging, berating and generally bleating to Government to make these changes. I have argued that NEST should be a Target Pension, I have railed at the tyranny of annuities and I have shouted out loud for the freedoms which the two bills in the Queen’s Speech give us.
Sure these Target Pension Plans will not provide the security of guaranteed annuities or even employer sponsored defined benefit schemes. Sure there is much to be done before we can deliver the finished article, but I reckon this further freedom is the missing piece of a jigsaw that includes better workplace pension savings plans, an upgraded single state pension and the new annuity framework.
I’m now going to ask you to raise your glass to David Pitt-Watson who has done so much to make this happen and finally I am going to toast Steve Webb MP.
Raise you glasses too to Kevin Wesbroom, Robin Ellison,Con Keating and Derek Benstead, champions of Target Pensions.
Finally I’d like you to raise your glass to the Queen- God bless you ma’am!
It is almost exactly four years since the Coalition came together. On May 10th 2010 I wrote a blog- we need to do something about annuities, the next day I wrote another about the formation of the coalition which I entitled “all changed,changed utterly, a terrible beauty is born“.
Raise your glasses to Steve Webb our Pension Minister and architect of CDC legislation.