Collective defined contribution (CDC) schemes will need to have clear rules on how to calculate pension transfers, so they can be compatible with pension freedoms, the Pensions Policy Institute (PPI) has warned.
The educational charity published a 64 page report entitled What is CDC and how might it work in the UK? today (November 29), which explores the potential benefits these schemes may offer and the hurdles they are likely to face in design and operation.
PPI said CDC schemes will have to incorporate demand for transfers out into their funding and investment strategy. For example, they would need to hold sufficient liquid assets to accommodate possible transfers out.
The charity suggested the schemes could offer set times at which members could transfer out of the scheme, although research suggests this could drive up transfer out rates.
The PPI said with the right scheme design and investment approach CDC schemes should be able to run in such a way they are compatible with pension freedoms, just as defined benefit (DB) schemes currently are.
The government launched a consultation on CDCs in the beginning of this month, as Royal Mail is set to create the first of these pension schemes in the UK.
CDC pension funds differ from defined contribution (DC) pensions because they do not produce individual pension pots. Instead they invest savings in a large collective pot which provides an income in retirement to its members.
They also differ from DB plans because do not guarantee a particular income in retirement and instead have a target amount they pay out based on a long-term, mixed-risk investment plan.
The Pension Schemes Act 2015, passed by the coalition government, included a provision for the creation of CDC schemes but the secondary legislation to create them was never introduced.
The consultation is also seeking views on what is the most appropriate methodology for pension transfers in these schemes and if these should be subject to a financial advice requirement.
In its report, PPI has suggested transfer values could be calculated either by the member’s own contributions to the scheme with interest added, or the value of the member’s accrued benefit rights multiplied by the funding ratio of the scheme at the time.
Some CDC schemes, like the ones offered in Canada, are designed so that the higher of these two values is offered to the member, it stated.
According to Lauren Wilkinson, policy researcher at the PPI, while CDC has the potential to provide benefits, there are also hurdles such schemes will need to overcome when being designed and run, in order to achieve these benefits and minimise risks.
She said: "Intergenerational fairness is one that’s often raised, but another significant challenge will be communicating the targeted nature of benefits to members.
"Both of these issues have caused tension among Dutch CDC members, so an important component of establishing CDC schemes in the UK will be in ensuring that scheme design can overcome these challenges."