Last week I ran a couple of meetings of the Friends of CDC, a loose affiliation of pension people with a view that CDC can offer a solution to some of the intractable problems people face in retirement.
Let’s start with the problem
There is no shortage of ways to build up money for your retirement, in fact there is a super-abundance of products from workplace pensions to Lifetime ISAs with a range of plans in between from SIPP to Stakeholder.
There is a shortage of choice as to how to spend your pension money (“wealth” as IFAs call it). There are three ways, the first is the scheme pension, which is what you get from a defined benefit scheme that pays a wage for life – (not a cash balance). The second is the annuity, the third is an individual drawdown arrangement. While most of us have the opportunity to buy an annuity or drawdown, few- outside the public sector – continue to build (accrue) rights to scheme pensions.
This is a problem. Megan Butler of the FCA went on Channel 4 news this week and told us that more than half of the DB transfer cases the FCA had looked at did not provide good advice. For whatever reason, the FCA considered that more than half of those advised would have been better off keeping their scheme pension than cashing out and relying on annuity and drawdown.
Despite this, we heard on the same day from Allan Johnston , Chair of BSPS Trustees , that over 12,000 of the 40,000 steelworkers eligible for a transfer, had asked for quotations.
There is considerable demand from people who want control of their retirement fund but too little supply. This is what is known as a market failure. The problem is that schemes can no longer afford to accrue scheme pensions and people have no easy way to pay themselves a wage for life.
What’s wrong with using an IFA?
Firstly there aren’t enough qualified IFAs to go round. Finding a Pension Transfer Specialist to help you take your decision isn’t as easy as it sounds, as the British Steel Pension Members are finding. Finding a good one is even harder. But you need such a specialist if you have a CETV paying more than £30,000.
Secondly, good IFAs will only advise you to transfer if you have special needs, simply thinking that you or they can do better than a scheme pension is not enough. You have to have a clear plan – either a specific cash flow need or tax reasons or perhaps self-confidence in your capacity to take investment risk. Most people don’t have such special needs which is why Megan Butler says what she does.
Sadly, there are a few IFAs who make matters worse by driving a coach and horses through the transfer analysis process for personal gain and this is making the problem worse. These rogue IFAs are not the main problem, the main problem is that most people should never forsake their scheme pensions in the first place.
People are right not to want to buy an individual annuity as a replacement for a scheme pension, it isn’t as good. People are right to be worried about drawdown, for most people – it isn’t as good. People need a wage for life – something that pays them a pension. That is not something that IFAs can help you with, IFAs help those with special needs and most of us don’t need them to manage our wage for life.
What’s right with CDC?
CDC – or collective defined contribution – provides a target pension. Infact CDC would better be called “target pensions”, which is why there is a target beside “the vision of the Pension PlayPen”.
This is something that drawdown can’t do. Annuities can provide a pension but the target is set so low most people don’t want it. Schemes are reluctant to target any more money at future pensions than they do at the moment. CDC is our best way of providing ourselves with a wage for life.
Right for big employers
Royal Mail and its membership (represented by the CWU) have agreed to pay scheme pensions in future using a CDC plan. These pensions won’t be guaranteed by Royal Mail who will only guaranteed a defined contribution for each member. The members know this isn’t as good as having a guaranteed pension , but 87% of them have voted for a wage for life rather than a “pension pot” which they’ll have to invest themselves.
Right for workplace pensions
Most bosses don’t have the Royal Mail’s history of paying pensions nor a workforce which expects to be paid a wage for life in retirement. They pay into DC workplace pensions using auto-enrolment. Many employers are new to paying anything into their worker’s pot at all.
Right now, most of these pots are very small but the workplace pension providers want to bring money to them and we think that were they able to pay benefits as target pensions , they would.
Right for people transferring away from DB
I totally understand and agree with people wanting out of schemes where they have lost confidence in their sponsor. It is what is happening at BSPS. But wanting out is one thing, managing your own pension another. The reason I am angry with the state of affairs at Port Talbot (and elsewhere) is that people are going into advised drawdown policies without the first clue of what they are doing, trusting the word of an adviser when many of the advisers are patently unfit to be giving such advice.
The good advisers are as angry as I am as they agree that most of the people going into drawdown plans should have gone for BSPS2 or the PPF and kept the right to a scheme pension. Megan Butler clearly agrees (and that lady deserves a lot of praise for what she said on Channel 4).
What ordinary people need if they transfer away, is somewhere to transfer away to. A target pension is a better alternative for most people than drawdown or buying an annuity. It can give people the freedom that annuities and scheme pensions can’t with the security that drawdown doesn’t.
Right for ordinary people
When most of us heard we would never have to buy an annuity again, we breathed a sigh of relief. If you read my blogs in the four years leading up to George Osborne’s 2014 budget you would hear me moaning about the rubbish value people with DC pots were getting with their savings. Pension Freedoms meant we didn’t have to worry about losing control of our money and we didn’t have to buy into rubbish annuity rates.
What we want is a wage for life with the freedom of having our money back if we really need it. My vision for CDC (target pensions) is one where even if the target pension is in payment, people still have the right to take their money away.
This right is essential for people to have confidence in the system. Deny property rights to people in CDC and you will have annuity 2.0 – people feeling their money is trapped.
CDC target pensions are likely to pay out more.
You will notice that so far, I have resisted the temptation of claiming people will get more from target pensions than from annuities or drawdown. That’s because that is not proven – it is just “highly likely” !
This is why;
- because these target pensions aren’t guaranteed, they can be invested for the long term – this allows the scheme operator to invest in “patient capital”, which provides a better deal over time than bonds and gilts, the short-term investments that back up annuities and scheme pensions (so they can be guaranteed). This long-term investment strategy is more suitable for long-term pension schemes and should allow them to pay higher pensions
- because these schemes are “collective” (the Royal Mail one would have 140,000 members day one), they have economies of scale meaning charges should be lower. This again should mean more efficiency than individual annuities and drawdown.
- because these scheme are centrally governed, they don’t need individual advice, which cuts out the cost of middlemen. This means that more of your savings come back to you,
- because we are all in this together, a CDC plan can self-insure the risk of us living too long. This allows CDC to pay a wage for life and not just till the money runs out. Insuring against living too long, is a central feature of CDC plans.
There are other advantages to a CDC plan but these are my big four. I’m not saying they are right for everyone (13% of the Royal Mail workforce didn’t want a wage for life) but I think they’re right for about 87% of us!
A small snag!
When you read this, you might be asking “why don’t we have these CDC target pensions today?” The reason is that while we have the enabling legislation for them (set out in the Defined Ambition section of Pensions Act 2015) we don’t have the secondary regulations which tell us the controls that need to be in place for these pensions to act within the law.
While organisations could set up a CDC plan today, it would be a foolish person who would, since without rules, such a plan would be a hostage to fortune (and ambulance chasers).
We saw the secondary regulations being built in 2015, but by the time this was going on ,we had a new Government , one that was more interested in bedding down the freedoms and auto-enrolment than writing regulations for a product for which they saw no immediate demand.
I now see considerable demand. Most obviously from Royal Mail but potentially from USS. We may have missed the boat with BHS and BSPS but they too could have moved to a CDC arrangement for future contributions.
I see demand growing among the master trusts to use CDC to pay target pensions. Some insurers may even see the target pension as better for the FAMR constituency , than advised drawdown. I see an immediate need for a default product for those transferring away from defined benefit schemes.
While in the very short-term, workplace pensions, advised drawdown and cash balance arrangements can pick up the slack, there needs to be a solution for the next decade. It will probably take 2 to 3 years to complete the secondary regulations – though this could be sped up with real intent from Government.
The snag is that we can’t do CDC or provide target pensions today. We need to get to it and start writing those regulations early in 2018. If we don’t – we risk the kind of disputes that we expected at Royal Mail and are expecting at USS. We will see more Port Talbots and we will see increasing numbers of DC dependent savers becoming frustrated with pension freedoms which prove illusory.
As one Port Talbot steel-worker said to me
“I want freedom from these freedoms!”
HERE IS THE CALL TO ACTION
Immediate positive affirmative action – write to Clark Charlotte STRATEGY DIRECTOR FOR PRIVATE PENSIONS <CHARLOTTE.CLARK@DWP.GSI.GOV.UK> and make a submission to the Work and Pensions Select Committee http://www.parliament.uk/business/committees/committees-a-z/commons-select/work-and-pensions-committee/inquiries/parliament-2017/collective-pension-schemes-17-19/