There is no doubt pensions needed transformational change; the term “pension” has of late become almost toxic. There are many reasons for this, however the major impacts have been a significant drop in the number of individuals funding pensions over the last twenty years and a lack of engagement in pension planning.
In an effort to get people to reconsider pensions, and to minimise the risk of state dependency, we have seen the introduction of a number of measures including auto-enrolment, the single state pension from 2016, and the proposed freedom and flexibility for defined contribution schemes from April 2015. The latest pronouncement from Steve Webb, the Pensions Minister, is the proposed introduction of collective defined contribution schemes (CDC). Is this the final piece of the jigsaw and the panacea that will see everyone re-engage with their retirement wealth planning?
CDC is being suggested as a half-way house between final salary schemes and defined contribution schemes. Supporters state that they reduce the investment and income risk for the individual. The member’s pension pot is not invested individually, rather it is pooled with all the other members’ pots, and pensions are paid from the collective fund, not by an annuity, therefore the individual doesn’t have to dis-invest when they take their benefits. The resulting economies of scale and cost efficient management are presumed to be the reasoning behind the suggested 30% uplift in pension income touted by UK politicians, when compared to that of a traditional DC scheme.
A number of countries are cited as exemplars of how well CDC works, one of these being the Netherlands. The Dutch schemes are split either by industry wide funds (e.g. retail sector, hospitality sector etc.), single company or corporation funds or independent professional funds, such as for medics, and therefore have the potential for many thousands of members. The Dutch experience though is not all positive. In 2013, 55 out of 415 CDC schemes reduced their pensions in payment. In addition there is concern over inter-generational cross subsidy, with the younger generation subsidising an unsustainable level of benefit for those already retired, and one that they themselves are unlikely to enjoy.
Constant change naturally leads to people being uncertain as to whether or not to take the necessary action, and pension legislation abets this by being in a constant state of flux. The steps taken so far under Steve Webb’s watch are admirable, however they also add further complexity to an already complex area. If, as proposed CDC is introduced in 2016, some companies may have a CDC scheme, an existing DC scheme (itself, still open to new members who do not want collective investment), and they may also have a closed final salary scheme. A retiring employee could therefore have their pension paid from three different sources, all from the same employment. Confused, I am sure they will be!
However, this is not to say we should do nothing, for to quote John F Kennedy, “There are risks and costs to action. But they are far less than the long range risks of comfortable inaction.” Therefore, perhaps we should quaff some “oude jenever”, embrace this new form of pension, and refrain from adopting our usual cynicism when it comes to change and more importantly pensions.
An abridged version of this blog first appeared in What Investment