Decumulation CDC is a natural fit for the UK’s maturing DC pensions

Many in the pensions industry, including the Institute and Faculty of Actuaries, are working to improve pensions adequacy, with the development of collective defined contribution (CDC) playing a part in this.

CDC schemes, a type of pension scheme that pools contributions and investments from a group of members, sharing risks and returns, are expected to deliver higher retirement incomes for a given contribution than traditional annuities, by targeting higher investment returns.

They “put the pension back into pensions” - in other words, provide members with a retirement income for life, rather than a pot of money to draw from. The level of income is not guaranteed, which provides the freedom to invest for the long term.

CDC has been making gradual progress in the UK, with Royal Mail opening the UK’s first CDC scheme last year, and regulations to allow a multi-employer form of CDC due later this year.

Now, the pensions industry and government are building up to a third form of CDC: “decumulation” CDC, with the minister for pensions stating a desire last month to introduce these schemes.

Decumulation CDC is designed specifically for ordinary DC savers to buy with their savings at retirement, to purchase an income for life which is expected to be higher than from an insured annuity – recent modelling from WTW suggests by an average of 40%.

DC pensions are on the verge of a major transformation

The Pension Schemes Bill 2025 will require “pension schemes to offer retirement products so people have a pension and not just a savings pot”, and DC trustees will need to offer their members “a retirement income solution or range of solutions, including default investment options”.

At the moment:

• DC trustees don’t usually choose or offer retirement options to members. Even in the heyday of annuities, it was usually the member’s responsibility to find out about the options available to them.
• The focus of DC member communications is often on the pot value rather than the sustainable income it can provide.
• Large proportions of members are not engaged with their pension options and do not know what to do at retirement. Many simply take all of their savings as cash, draw it down over a few years, or leave their pot untouched.

A retirement income default will dramatically improve on all of this.

DC needs a new retirement income option

DC trustees will need to assess for the first time which options will be most appropriate for their members.

It isn’t yet clear whether a form of guided drawdown might be enough to satisfy the requirement, as when used in isolation it won’t last for life unless the drawdown rates are very low or substantially drop in later years.

That would leave, at present, insurer annuities as the sole retirement income option. Despite improving prices from rising gilt yields, annuities are still unpopular with DC retirees, with only 8-10% of new DC retirees choosing them according to Financial Conduct Authority data.

Actuarial analysis tells you that annuity pricing is similar to gilt yields, so their purchase means that a saver is locking into among the lowest rates of return on the market, in order to get the income guarantee provided by the insurer.

DC trustees may well hesitate to choose annuities as the default option, given their price.

All of this suggests that there is a gap in the DC retirement space for a new form of retirement income that seeks to outperform annuities. And that’s exactly what decumulation CDC aims to do.

If the pensions minister can achieve his desire to facilitate decumulation CDC in time for the new DC regime ushered in by the Pension Schemes Bill, it is set to be the next big thing in how DC savers access income in retirement.

Simon Eagle is a member of the Institute and Faculty of Actuaries’ CDC working party.