Collective Defined Contribution pension legislation: RSA/Royal Mail response

CDCs to be introduced in the UK

The RSA today welcomes the news from the Department for Work and Pensions on the recent consultation on Collective Defined Contribution (CDC) pensions in the UK.

As the DWP Select Committee noted, they could be a “second Beveridge”.[1]

The RSA Tomorrow’s Investor project has been working for a decade to help policy makers understand the benefits of CDC, and is currently creating a centre of expertise, helping to support Royal Mail and CWU on the introduction of the UK’s first CDC pension.

The RSA consultation response noted that the proposals put forward by Royal Mail could be just a start, and that the benefits of CDC should also be available to other workers. Therefore the legislation passed for Royal Mail should be a foundation stone for further development. They suggest that legislative rules should not be too extensive. Rather “the process of authorisation, the publication of best practice, and the governance of the pension fund should be central to the provisions to make CDC safe and effective.”[2]

 

Commenting on today’s news, David Pitt-Watson from the RSA Tomorrow’s Investor project said:

“Today marks another step in the right direction for introduction of better pensions in Britain—ones which can offer an income from the time you retire until the time you die. We are delighted the DWP has indicated their desire to progress this, and that the responses to the consultation suggest widespread support.

“But there is still a lot to do to ensure that appropriate legislation is set in place, that Royal Mail and CWU are able to get their scheme launched in a timely manner and that one day everyone can save for a predictable retirement income.”

 

Jon Millidge, Chief Risk and Governance Officer, Royal Mail, added:

“This is very welcome progress. Royal Mail and CWU have been campaigning together to bring about this legislation, building a cross-party alliance of supporters in both Houses of Parliament as well as pressing Government to deliver. We now look ahead to the next stage, and ultimately, delivering the UK’s first CDC pension.”

 

The next step is the Queen’s Speech, expected in May or June, where the Government formally announces what bills it intends to bring forward.

 

The case study below, taken from the RSA response to the consultation illustrates why CDC pensions are so much more effective than alternative solutions. Further background on CDC pensions can be found at: https://www.thersa.org/action-and-research/rsa-projects/economy-enterprise-manufacturing-folder/pensions

 

Contact:

Ash Singleton, RSA Head of Media and Communications, ash.singleton@rsa.org.uk, 07799 737 970.

 

Notes:

Since 2008, through its Tomorrow’s Investor programme, the RSA has published an extensive programme of work on the feasibility of CDC pensions.

Matthew Taylor, chief executive of the RSA, recently led an employment review for the Prime Minister on the gig economy. Last year the RSA called for a single rate of pensions relief of 30% to encourage the self-employed save for retirement.

The RSA is an independent charity whose mission is to enrich society through ideas and action.

The organisation is led by Matthew Taylor, who recently authored the Taylor Review into modern employment practices for the Prime Minister.

Our work covers a number of areas including the rise of the 'gig economy', robotics & automation; education & creative learning; and reforming public services to put communities in control.

 

Case study: How CDC works 

 

Jo is saving for a pension, and wants to have enough to provide for herself from retirement until death. She intends to retire at 65 but, of course, does not know how long she will live for. She wants to be sure that she will have enough, even if she lives to be 100. That means she needs to save for 35 years of retirement. To do so, Jo will need to set aside £350 per month. The money will be invested in a way which seeks to give a balance of risk and return, and which aims to protect against inflation, etc. When she retires she will drawdown an income each year, with the aim of making her savings last for 35 years. The income secured cannot be guaranteed, but her investment is designed to meet the cost of a decent living in retirement. This approach is known as Defined Contribution (DC) plus drawdown. Of course if she dies before she is 100, there will be money left in her will. 

 

However, Jo also understands that her likely life expectancy, together with everyone else in her company is 85. That means that if they were able to save for a pension collectively, she and her colleagues would only have to save enough for 20 years. As with any insurance, those who die young might be said to be ‘subsidising’ those who live to an old age. But everyone knows they will be provided for until the day they die. This reduces the cost a lot. If saving for 35 years costs £350 per month, savings for 20 years might cost £200 a month. This approach is known as CDC. DC plus drawdown is thus 75 percent more costly than CDC, if the aim is an income in retirement and the money is invested in the same way. 

 

The only other way Jo can get an income for life, is to buy an annuity. An insurance company provides these. To be sure that the payment is ‘certain’, the insurance company invests only in ‘safe’, low return securities. Once in retirement, these provide a very predictable income, albeit that annuities often do not offer protection against inflation. That is not a big concern today, but might well be in the future. Equally problematic, the cost of an annuity varies with the cost of ‘safe’ securities, so before retirement, it is difficult for Jo to determine how much she will need to save. And annuities are expensive. As a result, Jo needs to set aside £270 a month, 35 percent higher than CDC. This approach is known as DC plus annuity. 

 

In summary, if the cost of a decent living in retirement is £200 per month using CDC, it will be £275 per month for DC plus annuity, and £350 for DC plus drawdown. That is why, properly managed, CDC can offer a higher income in retirement for the same cost as other available pensions. 

 

Note that these figures are developed only for this simplified example. However they are consistent with the extensive studies that have been done on CDC. These are reviewed in Appendix 1 of this paper. These studies have been undertaken by government, academic and professional bodies. Two of them have been commissioned by the DWP itself. All tell a similar story, that if the objective is to achieve an income which will last for the rest of an individual’s life, CDC will achieve an outcome at least 30 percent higher than DC. It will also be more predictable.