New pension scheme launches today – and it could mean you get more cash in retirement

The Governent has launched a new sort of hybrid pension that claims to offer the best parts of existing sorts of retirement savings – all that’s left is for employers to buy into the idea

A new type of pension has launched – and it could mean better payouts in retirement than current workplace pensions.

Until today Brits had one of two sorts of workplace pension – defined benefit (DB) or defined contribution (DC).

Old-fashioned DB pensions give a guaranteed, often very generous, payout in retirement. They are also known as “final salary” pensions.

But as life expectancies rose and investment returns fell, DB pensions started to die out in favour of less generous DC ones – which most workers now have.

But now the Government has blended the two to launch a new sort of pension – collective defined contribution (CDC).

The Department for Work and Pensions (DWP) said CDC pensions could mean more money for retirees.

Minister for pensions Guy Opperman said: “CDC schemes have the potential to transform the UK pensions landscape.

“We have seen the positive effect of these schemes in other countries and it is abundantly clear that, when well designed and well run, they have the potential to provide a better retirement outcome for members, and can be resilient to market shocks.

“I have no doubt that millions of pension savers will benefit from CDCs in the years to come.”

It is now down to employers to set up a CDC scheme that their workers can sign up to.

Becky O’Connor, head of pensions and savings at stockbroker interactive investor, said: ““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.”

The Royal Mail has been the guinea pig for the UK’s first CDC scheme, which it launched this year.

How do CDC pensions work?

The basic idea is that a workplace sets up a CDC pension scheme that workers and their employers save into, just like DC pensions today.

The difference is that the pot of cash is then shared among all members of the scheme, rather than each employee saving an individual pot.

In theory, that collective saving means much higher returns than DC pensions – though pension firms are very shy about saying this outright in case it all goes wrong.

Pensions work by money submitted being invested and growing as it earns interest over time.

Normally pension firms have to have a limit on how much high-interest investment they have.

That is because high-interest also means high risk, and this needs to be balanced out with safer investments that earn less interest.

But a pension company running a CDC pension can pick much riskier investments – again, in theory.

The idea is that the huge sums invested in a CDC pension pot can overall absorb the shocks of high-risk investments dipping in value.

All workers in the pension pot share the gains made in the good times, and the losses made in the bad times, but it should balance out in favour of bigger pension pots than DC schemes.

Why are CDC pensions launching?

The Government first brought in laws to allow CDCs back in 2015, but Brexit and the Covid-19 pandemic put this on ice.

Do CDC pensions work in practice?

The short answer is that they can, and they have been launched outside the UK in countries such as Canada and the Netherlands.

In the Royal Mail scheme, staff put in 6% of their salaries, and the postal firm tops that up with an extra 9% – which is pretty generous.

The Royal Mail scheme is 100% invested in relatively high-risk investments known as equities, or stocks and shares.

This is unheard of among pension firms, which normally have around 30% invested in equities.

In addition, as workers get near retirement their pensions slow down how much they earn.

This is to protect individuals from sudden falls in the value of their pension pots from being over-exposed to volatile stock markets.

The advantage of CDC pots is that there is no need for that caution, as the entire pot is invested in the same way.

In theory that means higher payouts for Royal Mail pensioners on the CDC scheme.

What are the problems with CDC pensions?

One issue is if stock markets around the world see big, long-lasting falls.

If that happens, pension values fall too. Any CDC scheme with high exposure to stock markets – which will probably be most of them – would take a big hit.

That would mean reduced pension pots for people retiring.

But even then, these CDC pensioners would be better off than those on DC schemes, according to broker Aon.

An Aon document says: “But during those periods, members in DC would probably still be worse off, given they bear all risk on their own, and their time-horizons for saving are typically much shorter than in CDC, so they have less time to recoup any falls in their savings.”