Workplace pensions are about to experience a succession event
company - not ideal if the core capability passed down through the family is making our daily bread, transforming the built environment, or brewing beer and serving it in pubs.
them for their remaining years.
Collective Defined Contribution (CDC) offers fresh hope for a rising generation of workplace pensions – promising higher pensions, payable for life, and without additional costs or obligations for employers. Ask employees what they want from their pension. Most tell you they want a stable income that lasts as long as they do and rises with the cost of living. They also want someone trustworthy to manage it for them, so they don’t have to think about it. Ask family business owners what they want for employees after a lifetime of service. Most say they want to reward loyalty with a dignified retirement that provides a moderate level of comfort. They also say they don’t want to create open-ended commitments that future generations will need to stand behind.
CDC - the next generation of workplace pensions
Defined contribution
There will soon be a third option for workplace pensions which will better meet the needs of employees and align more comfortably with the values of most family firms. Collective Defined Contribution (or “CDC”) schemes combine elements of DB and DC. l Just like DB schemes, employees build up an annual amount of pension that is payable for life and is expected to increase with inflation each year. The main difference is that the amount of pension is not guaranteed. l Just like the DC schemes, contributions are fixed for employers and there is no balance sheet commitment or ongoing liability to pay more in the future. Members will bear all the risks, but they will do so collectively with current and future members. The sharing of investment risk across generations of members allows a CDC scheme to invest for the very long- term in a wide selection of asset classes, including private markets and productive investments, which promise higher returns.
DB pensions have been replaced with Defined Contribution (or “DC”) schemes. In a DC scheme, contributions are paid into a “pot” for employees to access when they retire. Whilst they offer flexibility and certainty of cost, they also transfer all the risks for investment performance, inflation, and life expectancy to employees. There are three reasons why DC pensions don’t compare well with our basic tests: l Firstly, contributions going into DC schemes are not adequate to provide a moderate level of retirement income for most people. According to the Pension Policy Institute, the average employee receiving the statutory level of contributions for their working life can expect to live a comfortable retirement for just four years. For current retirees, it’s just two years. l Secondly, contributions need to be higher to compensate for inefficien- cies in the design of DC investment strategies. Because individual DC savers carry the risk of market volatility, money is switched automatically into safer, lower-returning investments in the run-up to retirement. l Thirdly, DC schemes don’t provide pensions. When employees retire, they face a set of complex decisions about how to use their pot. If they want an income, they need to choose between an expensive annuity or a drawdown product, which may or may not last
Defined benefit
Defined Benefit (or “DB”) schemes used to deliver these essential requirements with a lifetime pension linked to service and salary. In a DB scheme, the pension is guaranteed, and the employer is legally obliged to fund the promised level of benefits. There are 500 family firms in the UK with DB schemes. Most were set up by a previous generation when there was only a “best endeavours” commitment to securing the promises they had made. It’s thanks to those “pension founders” that a store of wealth has been created (at the last count £40bn) to sustain several generations of employees in retirement. Regrettably, DB pensions are in terminal decline. The costs, risks, and complexity of managing them now are akin to operating a life insurance
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