Interactive Investor

There is a ‘third way’ for workplace pensions

1st August 2022 12:10

Rebecca O'Connor from interactive investor

interactive investor comments on the launch of collective defined contribution schemes.

A new kind of workplace pension – the collective defined contribution scheme – officially launched today.

Collective defined contribution (CDC) schemes are a kind of hybrid between defined benefit and defined contribution. They aim to deliver some of the benefits of both by allowing savers to pool money into a single fund that pays annual pension income, which is likely to vary but is expected to be higher than income paid by a standard annuity.

Becky O’Connor, Head of Pensions and Savings, interactive investor, said: “Collective defined contribution schemes offer a much-needed ‘third way’ for workplace pensions. They aim to solve some of the risks of defined contribution schemes, ie. the risk of managing drawdown or poor investment choices and offer some of the benefits of defined benefit schemes, ie, reliable retirement income and hopefully more generous outcomes. 

“They are likely to only be offered by larger employers initially but over time, could be offered by smaller companies, too. 

“Access to them will be dependent on where people work, however, so don’t get too excited, you won’t be able to simply choose a CDC for yourself. 

“For the time being, defined contribution schemes remain the most likely type of pension someone will find themselves enrolled in through work. With defined contribution schemes, what you get out at the other end of a lifetime of saving remains largely in your own hands, with employer contributions generally lower than those from the employee. 

“However, if your employer does happen to offer generous contributions that match or even double match your own up to a level higher than the auto-enrolment minimum, it’s wise to take advantage if you can.

“For people who want control of their own pension investments, CDCs are unlikely to appeal as much as self-invested personal pensions.”

Types of workplace pension

Defined benefit: your income in retirement is determined by the number of years you have worked (career average) or by your final salary. Typically more generous retirement income levels than with defined contribution. Often known as ‘gold-plated’. Both employer and employee pay in – employers tend to pay in more than with defined contribution schemes (see below). No ‘pot of money’ to build up or drawdown, or leave to relatives. Prevalent in the public sector. Some, usually larger private sector employers offer them, too, although they are in decline. They were the most popular form of workplace provision among employers in years gone by but have now been superseded by defined contribution schemes.

Defined contribution: your income in retirement is determined by the amount you manage to accumulate in your pension through your own contributions, your employer’s, tax relief and investment growth. Under auto-enrolment, employees pay in a minimum of 5% into these schemes and employers, 3%. When you retire, you have options for how to access the ‘pot of money’ and can continue to invest it. High degree of personal responsibility for making the pot grow and then last. You can leave money left in the pot to relatives after you die by nominating beneficiaries.

Collective defined contribution: workers’ contributions are pooled together and invested on their behalf. Relatively reliable retirement income is then paid to retirees from the shared pot, with variable increases. Unlike defined contribution drawdown arrangements, there is no risk of someone running out of money in retirement.

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