Taking centre stage in the Queen’s Speech

This year is best described as the year of the pension. After grabbing the headlines following the Chancellor’s Budget 2014 speech, pensions were once again top of the agenda. In an 11-bill programme, pensions took centre stage, with major changes to annuities and workplace schemes also announced.

T he plans to make significant changes to pensions were also a central theme in the Queen’s Speech. The Government abolished the requirement for people to buy an annuity and is considering alternatives whereby workers contribute to ‘collective pension’ funds, which they would share with thousands of other pensioners.

GIANT POOL 
The Collective Defined Contribution (CDC) is based on the Dutch pension system. These schemes work as follows: an employer contributes a fixed level related to your average salary, and this makes up the ‘Defined Contribution’ part. Members of the pension scheme also pay contributions at a specified level. All contributions go into a giant pool of assets – the ‘Collective’ element. Over time, a substantial fund is built up which pays out a pension linked to your salary once you reach the scheme’s pension age.

The theory is that these schemes are better for employers than traditional final salary schemes (Defined Benefit or DB plans) and better for employees than standard occupational pension schemes – Defined Contribution (DC) plans. For employers, this is a much cheaper option than the gold-plated but fast disappearing DB schemes, as there is no balance sheet risk attached. Employees, meanwhile, receive a level of pension related to their career average salary with discretionary inflation protection.

LONGEVITY RISK 
Pooling assets can also create economies of scale, which means savings both in managing investments and running the scheme, which in turn enables higher pensions as less money is taken out in fees. As such, CDCs are seen to be particularly beneficial for those on low incomes or saving small amounts of money, as savings are not eroded by individual charges. These schemes also have the benefit of pooling the longevity risk in pensions, much the way an annuity does (but without the guarantees).

Collective Defined Contribution schemes may suit some savers who have no intention of controlling their pension and who don’t want to choose where to invest. Once retired, savers in such schemes would also have to accept that their pension income could fall during their retirement. These collective pensions may not allow savers to enjoy the pension freedom announced in the Budget, or if they do, may impose penalties for those who wish to use this flexibility.

These Collective Defined Contribution schemes would be made available through employers if they are ever introduced. In reality, it will be many years before such a scheme becomes available.