The New CDC Pension Scheme: What You Need to Know

The UK is now introducing a Collective Defined Contribution (CDC) scheme structure, which shares features with both defined benefit and defined contribution schemes. Royal Mail will be the first organisation to introduce the new scheme type, but if the rollout is successful, there is a strong chance that other employers will follow suit.

In this guide, we look at the main scheme types in the UK, explain how the new CDC scheme works, and consider how you may be affected.

A Brief Guide to the Main Types of Pension
In the UK, there are two main types of pension scheme.

A defined contribution scheme allows you to build up a pot of money from which you can eventually take a retirement income. The income you receive will depend on the amount you pay in and the investment growth achieved. You can set up a defined contribution pension yourself (a personal pension), although many employers also offer them. The pension can be passed on to your loved ones if you die.

Defined benefit pensions are less common today, and are mainly available to employees in the public sector. Many of even of the largest corporations have closed their defined benefit schemes in favour of defined contribution, although members still keep the benefits they have built up. A defined benefit scheme puts all the risk on the employer as members are guaranteed a set level of income dependant on their salary and years of service. This may be based on their final salary or averaged throughout their career. The scheme will also normally provide some death benefits, for example, a 50% spouse’s pension.

The new CDC scheme will introduce an entirely new pension structure, offering employers and employees a ‘middle ground’ between defined benefit and defined contribution.

What is a CDC?
CDCs are new in the UK, but are already widely used in Canada, Denmark, and the Netherlands.

A CDC would work as follows:

• The scheme is managed by trustees.
• Members and employers pay a fixed rate of contributions. Members may also be able to increase their contributions if they wish. For example, in the new Royal Mail scheme, the employer contribution will be 13.6% of salary. Members will pay 6%, with the option of increasing this by 1%.
• The investment fund is invested by the trustees and pooled between members.
• The scheme is valued every year so that members have a reasonable idea of the income they could receive in retirement.
• The aim is to provide retirees with an increasing pension, although the income will be variable depending on the investment returns achieved.

Who is it For?
CDCs are best suited to large organisations, as smaller companies won’t have the resources or economies of scale to manage the scheme effectively.

CDCs are unlikely to be offered by companies which currently offer a defined contribution scheme. They are more expensive to provide and carry additional responsibilities.

Royal Mail introduced the CDC option to replace its closing defined benefit scheme. This suggests that other organisations, including those in the public sector, may consider this as an alternative to providing members with guaranteed benefits.

What Are the Advantages?
On the assumption that a CDC is being offered to replace a defined benefit scheme that was already going to close, it offers a number of advantages over moving to a defined contribution scheme:

• The pension fund is invested by the trustees. This means that you don’t need to make investment decisions.
• The fund is pooled between members so that they share the risk. This means that retiring members don’t need to worry about a dip in the market just before they take their income. It also means that retirees don’t need to worry about running out of money.
• This also means that the scheme can take a higher degree of risk with its investments, which can improve returns.
• Larger schemes may also benefit from reduced costs.
• As the scheme is revalued annually, you should have a clearer idea of your potential benefits than with a defined contribution scheme.
• It is estimated that members will receive a higher level of pension income than with a defined contribution scheme.
• As employers don’t guarantee the level of income, there is no ‘risk premium’ reflected in the contribution rates.

Potential Downsides
There are, of course, a few potential disadvantages with the new scheme:

• As the concept is still relatively new in the UK, we have yet to see how this will work in practice. Some details are still unclear, for example, the death benefits that will be available.
• Compared with a defined benefit scheme, members may receive a lower level of income without any guarantees.
• Members might find the new scheme difficult to understand, which could affect the take-up rate.
• Members will have less control over their investments, income, and death benefits than with a defined contribution scheme.
• Transferring benefits when moving employers may not be straightforward, particularly when the scheme is still new.
• Pooled schemes can be challenging to run, in particular, balancing fairness for current members versus retired members. Paying higher pensions now could reduce the amount available for younger members.

Should You Join?
Royal Mail will offer the choice for members to ‘opt out’ and invest in a standard defined contribution workplace pension instead. Members who take this option will have more control over their retirement, benefits, but will miss out on the advantages of using a pooled scheme, for example, reduced costs, spreading the risk, and a more accurate projection of their retirement benefits.

Unless you work for Royal Mail, this is not a decision you have to make now. If your employer offers the option in the future, it’s a good idea to read the scheme literature thoroughly, ask lots of questions, and seek advice if necessary.

Remember, your retirement is not solely dependant on the scheme offered by your employer. You can make additional contributions to a personal pension if you would like to boost your retirement pot or allow yourself more flexibility.

Please don’t hesitate to contact a member of the team to find out more about retirement planning.