Introduction

Collective Defined Contribution (CDC) schemes were formally introduced in the UK via the Pension Schemes Act 2021 and offer an additional option to the UK pension landscape which many believe will help people achieve a better retirement.  CDC schemes work by members and employers making fixed contributions into a collective fund, these schemes then pool together funds with other members. This collective investment management means that trustees of the fund have more freedom to invest in high-risk assets which may provide higher investment returns. It is therefore hoped that CDC schemes will in turn provide a higher average pension throughout an individual’s retirement.

We have previously touched upon CDC schemes in our article about the Pensions Regulator’s Corporate Plan for 2023 to 2024, which you can read here.

Apart from the interest that "whole-life"¹ CDC pension schemes have garnered, there has also been interest in the potential for CDC decumulation only schemes. In a public consultation published in January 2023, the Department for Work and Pensions (DWP) explored the introduction of legislation for CDC schemes exclusively for decumulation with the view of helping “improve member choice and outcomes”. A response to the outcome was published in July 2023, which noted that the government are committed to continue working with interested parties to develop an appropriate legislative framework for decumulation only pension schemes. The response also mentioned that the government intended to consult on draft regulations to extend CDC provision to whole-life multi-employer schemes including Master trusts, in the Autumn of this year.

In this article, we look at the extent to which joining a CDC pension scheme may form a valued addition to the existing choices available to people on retirement and how, when looking at decumulation, there is scope for CDC schemes to improve outcomes for pension savers.

Background: Whole-life CDC pension schemes

In the past few decades, there has been a major shift in pension plans offered by private-sector employers, from the traditional defined benefit (DB) pension plans to the more employer friendly defined contribution (DC) pension plans.

DB pension schemes generally promise to pay guaranteed inflation-linked pensions for life. However, valuation issues, members continuing to live longer, the uncertainty placed on employers and the huge cost of providing retirement benefits have meant the number of employers offering DB schemes has dramatically declined over the past few years, with the number of private sector employees that are still accruing new DB benefits reducing from 3.5 million in 2006 to just under 0.9 million in 2022.

Whilst DC schemes are more affordable for employers, they do not pay a guaranteed amount and employers have no liability to provide a specific level of income for employees. This has placed a burden on an individual worker to contribute enough to their pension to generate a satisfactory return to provide for their retirement, and fluctuations in markets can lead to poor investment performance, which in turn can make for a less than comfortable retirement.

CDC pension schemes can be seen as a hybrid of both DC and DB and are emerging as a third option. Like DC schemes, CDC pension schemes work by employers and employees making fixed contributions. The aim of the scheme is to supply funds in retirement with a target in mind, similar to DB schemes, but with the potential of variable increases and the possibility of decreases.

Unlike traditional DC plans, CDC schemes pool the contributions from all members into a collective investment fund, which is invested by trustees for future growth over time. As funds are pooled from several participants, risk is shared by members of all ages. In its consultation response, the DWP says this risk sharing means "CDC schemes are more resilient to market shocks" as a collective buffer can be created which can absorb market fluctuations. However, CDC schemes are not without their issues. Perhaps the biggest downside is that target income is not guaranteed. Whilst pensions are expected to increase, benefits are subject to adjustments which can be problematic in times of an economic downturn. This means there is always an element of unpredictability with CDC schemes – which could be a reason behind the slow uptake of CDC schemes as employers will have to manage employees’ expectations that the schemes benefits are not guaranteed.

In August 2022, the Code of Practice from the Pensions Regulator for CDC pension schemes came into force, which is primarily aimed at those involved in the operation of a CDC scheme, such as trustees and their advisers. Following this, the UK’s first CDC scheme – the Royal Mail Collective Pension Plan – was confirmed as authorised by the Pensions Regulator on 13 April 2023. 

CDC decumulation products 

As well as whole-life CDC schemes, there has been much interest in the potential for a CDC decumulation only scheme and how they may increase member choice and outcomes. The DWP, in its consultation response, mentions that there have been suggestions that CDC decumulation only schemes could be a natural extension of the single or connected employer regime that has been introduced, as well as the whole-life multi-employer and Master Trust framework. 

Whilst there are similarities with whole-life schemes, a decumulation only CDC scheme has some key differences. In whole-life schemes, as mentioned above, both members and employers contribute to the collective fund. This fund is invested and the contributions/investment performance determines the member’s share of the assets over time. 

However, a decumulation only CDC scheme means members transfer to the scheme at the point of decumulation. The value of their pension savings at this point determines what pension income the member might receive, which can be heavily dependant on market conditions and other factors relevant at the point the member decumulates. 

A CDC decumulation product would allow the purchase of an income payable for the retirees life at a variable rate. This is similar to purchasing an annuity with the primary difference being that there is no guarantee of the level of income. Instead, the CDC scheme would invest in high growth assets and, due to the element of risk sharing involved, would have the potential to provide, on average, better returns than the traditional options of annuities or drawdow.² All of this means that CDC decumulation products may be able to provide a huge benefit to pension savers by offering an affordable regular income in retirement. However, whilst members would have the benefit of a fully managed investment fund that can provide them with an income for life (although the annual benefit level is not guaranteed), a CDC decumulation product may be complex to understand. This could be problematic as it would be another option that needs to be explained to retirees, who may already be overwhelmed by the retirement choices they already have. 

In their consultation response, the DWP has noted that “stakeholders acknowledged that careful consideration is needed.” For instance, there may be issues when calculating a members projected benefits from the scheme as well as problems relating to the pricing mechanism used at decumulation. Further considerations include how the set-up and provision of such products would be funded, how sufficient scale would be achieved, the overall sustainability of the products and how a fair buy-in price will be delivered for prospective members over such arrangements’ lifetimes. 

The DWP has laid down key principles they want to retain for decumulation only schemes which include:

• the CDC benefits in these schemes must be collective money purchase benefits.
• the arrangements would be offered through a trust based occupational pension scheme.
• such arrangements will require authorisation and supervision by the Pensions Regulator to help ensure only well designed and well-run schemes can operate and to protect the interests of members. 
• CDC benefits in these schemes would be subject to annual valuation and adjustment.

Conclusion

Whilst there is potential for CDC pension schemes to add value as a decumulation option, it would become another option presented to retirees when they may already be overwhelmed with the options before them. However, if retirees are suitably informed when exercising their options, and if the above considerations are addressed, then CDC benefits may become an attractive decumulation option. Looking at the future of CDC decumulation products, in the DWP’s consultation response, they have stated they will explore how such products could operate in the best interests of members and that they will continue to progress with moving forward to create a provision for such products. 

1. The reference to "whole-life" refers to both the build-up of funds in the pension scheme during a person's working life (the accumulation phase) as well as the taking of benefits on that person's retirement (the decumulation phase). ↩
2. An annuity is a fixed income that is received from an insurance company for the rest of the recipient’s life or for a specified period. They are financial products offered to retirees that are secured by the payment of a capital sum. A drawdown is another way of receiving pension income, whereby the retiree makes withdrawals from their pension pot as and when they need to. ↩