Those who die early cross-subsidise those who die later
CDC pensions are expressed as a lifelong income and that income stops on death. In contrast, DC pensions are expressed as a pot of money, and under income drawdown any part of an individual pension pot that has not been used by the member is returned to their estate on death.
While at first sight this might appear to be a disadvantage for CDC, there is in fact scope to set an appropriate level of death benefits within a CDC scheme.
For example, upon death of the member, their CDC pension can continue, perhaps at a reduced rate to meet the needs of a surviving spouse or dependent partner.
In addition, a lump sum can be payable on death before retirement, or in the first few years of retirement, to avoid the perceived unfairness of a member having saved for many years and then receiving a pension for a very few years before early death.
However, those who have saved up far more in their pension than they expect to spend over their retirement, and who are keen to leave any excess pension money to their children and/or grandchildren on death, might be best advised not to choose a decumulation CDC.
Trustees choose investments, not members
It has become common for DC schemes to offer members a range of investment funds to choose from. Some may choose elevated risk strategies such as Chinese or Russian equities and prosper if their choices fare well. Others may opt for safety, choosing funds that target low volatility.
However, members of a CDC scheme have no choice; the trustees, in conjunction with their professional investment advisers, will select all CDC investments.
If clients want to pick their own stocks, screen out ‘nasties’ like tobacco and alcohol, or follow a more aggressive carbon neutral strategy than the Paris commitments the trustees may be targeting, then they will have to stay in DC and drawdown to do so.
Although all CDC assets are pooled together, an ingenious part of the CDC design smooths the member experience through the mechanism of adjusting the annual pension increase.
While for all members a change from say 3 per cent to 2 per cent annual increase seems small, it represents a rather bigger change for younger members than older members.
In this way, the CDC scheme automatically pools the risks intergenerationally, meaning that younger members will be exposed to, and benefit from, rather more of the higher volatility investments than older members, even though this exposure is largely unseen behind the calm exterior.
In conclusion, the arrangement of pensions in a collectively pooled manner is a much more efficient framework that translates into a projected one-third or more higher retirement income than current DC plans.
