With collective defined contribution (CDC) rules now laid before parliament, Roberto Marrocco, a policy adviser at the Association of British Insurers, explains why communicating this new structure needs care and attention to detail.
CDC pensions are being hailed as a new way to deliver retirement income, but behind the headlines lies a complex reality that savers and policymakers must understand.
Whole-of-life CDC pension schemes pool contributions from employers and employees into a single fund collected throughout scheme members’ working lives. On retirement, members then receive their pension benefits from the pooled fund.
The main selling point of CDC is that customers do not have to make a complex decision – almost like receiving a defined benefit (DB) pension.
However, prospective members must also be told very clearly that, unlike a DB scheme or an annuity, pension income can fluctuate. Unlike a drawdown product, there will be no prospect of assets to pass on. The pension you receive will depend on the financial position and performance of the fund at the time your cohort enters the fund.
Unrealistic expectations
It’s concerning to see the rhetoric that CDC schemes can deliver ‘60% more’ than other retirement options – this is misleading. That number relates to whole-of-life CDC rather than retirement CDC.
Moreover, the comparison is with the most prudent alternative possible: index-linked annuities, which are in practice a less frequently used product.
Retirement-only CDC is a newer concept that applies only at retirement. It allows individuals with existing traditional defined contribution pension pots to pool savings and convert them into a CDC-style lifelong income.
Similar to whole-of-life CDC, retirement CDC offers security through an income for life and even has a target to increase each year in line with inflation. But consumers should be made aware that additional products with similar characteristics already exist.
A drawback to retirement CDC is the risk of a fall in income. Crucially, there is currently no requirement to have capital reserves to protect members from investment losses, which is the case with the Solvency UK framework for annuities.
Investment losses are not just a theoretical issue, and we should take lessons from abroad.
In the Netherlands, for example, pension funds can adjust the pension benefits they pay out. An International Monetary Fund report from June 2024 found that “many pension funds, including the largest, have not been able to afford indexation since the global financial crisis and have only in 2022 re-started indexation again”. It later notes “some funds have actually had to reduce pension benefits”. Ensuring savers are aware that benefits can go down as well as up is vital.
Putting CDC into practice
Customers often want a degree of flexibility built into their retirement plans, mainly to account for any adverse events they experience. However, current proposals mean that joining a retirement CDC scheme is an irreversible decision. Serious consideration is needed to allow for a ‘cooling-off’ period to be available for customers if they wish to change their mind, as seen with other retirement products.
‘Flex, then fix’ blended solutions offer an alternative to retirement CDC. Here, savers start their retirement journey in drawdown but switch later to an annuity. It’s understandable that this solution is often spoken about as a default pension benefit solution for guided retirement. They are seen to offer flexibility in early years, while ensuring security in later life through annuitisation – meeting the policy intent of providing an income for life.
There are also questions over who can offer retirement CDC pensions. The government has reiterated that there is no appetite for contract-based providers to offer these structures, but this is an unrealistic assumption. Providers regulated by the Financial Conduct Authority should be given the opportunity to offer this product to their customers without the need to partner with a master trust entity.
CDC pensions could offer value, but only if risks, limitations, and governance are communicated transparently. Customers should have accurate information to help them choose the solution that best suits their circumstances.
The promotion and marketing of these schemes need to reiterate that customers can and should shop around. Policymakers and providers must ensure members understand what they’re signing up for because once in, there’s no turning back. Handle with care.
Roberto Marrocco is a policy adviser for long-term savings at the Association of British Insurers
