Should we go Dutch with our pensions?
The Coalition wants to adopt Holland’s pooled system. Would we benefit by taking the plunge?
So-called Dutch pensions are expected to be the cornerstone of radical retirement reforms announced in the Queen’s Speech tomorrow.
The collective schemes have attracted that term not because they share resources, but because they are popular in the Netherlands.
The plans do pool savers’ investments to create mega-funds that aim to meet future pension payouts of scheme members.
There is also the hope that they could help cut back on expensive fund management commission charges, leaving more of savers’ cash to grow in their pension pot. It is claimed that the schemes have the potential to increase members’ pension income by 30 per cent or so.
Pensions Minister Steve Webb is a well-known fan of Collective Defined Contribution (CDC) schemes and has called them “some of the best in the world”. He said: “It is pretty unambiguous that you will get a more certain outcome and potentially a better one.”
Critics disagree. They point out that returns are not guaranteed, with savers only given targets, which may fail to be met. In fact, problems in Holland have led Dutch politicians to call for the schemes to be scrapped in favour of British-style individual pensions.
Pros: It is the certainty of cost that makes CDC pension schemes attractive, say experts.
“CDC plans have held the promise of providing the combination of certainty of cost for the employer along with straightforward access to a retirement income for members,” says Matthew Arends, partner at Aon Hewitt. He predicts that many employers will want to use CDC “as a core part of retirement savings to provide an income in addition to flexible DC cash savings”.
Henry Tapper, founder of the Pension PlayPen, is also a fan. “CDC should be the final piece in the jigsaw that allows those looking for an alternative to annuities, to optimise their pension spending,” he says.
He points out that the idea is not complicated and therefore the schemes themselves need not be confusing, unlike existing pension schemes. “CDC can be integrated into our existing pension framework relatively easily. It is no more than a return to the vision of pensions that existed before the calamities of the past 30 years,” he says.
Former Treasury adviser Ros Altmann welcomes the potential launch of the schemes, but with some reservations. “One has to bear in mind that CDC schemes are not even established yet, they take time to deliver and they do have some disadvantages too,” she says.
“Nevertheless, I think the Government is right to legislate to permit these schemes as they can be better for employers than traditional Defined Benefit and also better for members than pure defined contribution [DC] schemes. By allowing CDC schemes, the Government is offering employers a less onerous system of promising pensions to their staff.
“The employer will no longer have to carry balance sheet risk from the pension plan, as the contributions are defined and the benefits can be adjusted if necessary.”
Most employers now use DC pension schemes, which produce pension payouts based partly on the amount you put in and partly on how well your investments perform.
The collective nature of the new CDC schemes means the investment risk is shared across potentially millions of savers, cutting down the chance of your pot shrinking.
Danny Wilding, partner at actuary Barnett Waddingham, says the introduction of new rules will mean a need for new types of schemes which can take advantage of them.
“CDC offers a viable alternative to employers who wish to help support staff in retirement, and strikes more of a balance between employee and employer responsibility for pension arrangements,” he says.
Cons: The uncertainty of returns make CDC pension schemes unattractive, say experts.
“The new schemes will allow one generation of member to receive more pension, in the hope that future investment returns will ultimately justify the decision, but that has significant risks involved,” warns Alan Higham, retirement director at Fidelity.
“Younger people may bear the cost in reduced future pensions should these judgments prove flawed and pensioners may see their income fall or, in extremis, see income clawed back.” He also criticised the timing of the announcement given that – as announced in the Budget – people are to be given total freedom to take their full pension fund at retirement from 2015.
“These inter-generational risk-transferring CDC schemes rely on both younger savers staying in and older savers keeping their money invested at retirement,” he says.
“Many people will prefer taking a full lump sum over a short period at retirement, which makes running these schemes challenging.”
Tom McPhail, head of pensions research at Hargreaves Lansdown says there used to be collectivised pensions in the UK, but they were called with-profits funds.
“Investors now shun these investments because of their complexity, lack of transparency and poor management,” he says.
“The big problem is that CDC schemes are based on collective risk-sharing, with individual interests subordinated in pursuit of better overall returns for all. They work very like with-profits funds with actuaries using their skill and judgment to share returns across members and across generations of members.
He also believes the schemes probably won’t be subject to the newly announced pensions charge cap of 0.75 per cent, which could leave members facing heavy additional premiums to cover the cost of hedging the fund investments
Richard Jones, managing director of Punter Southall Transaction Services, warns that in times of extreme distress pensions can actually be cut. “CDC schemes are common in the Netherlands but have become increasingly unpopular as recent poor investment experience has led to the suspension of annual increases for many years and for some schemes to have had to cut benefits,” he says.
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