Pensions: Collective Defined Contribution (CDC) schemes

Collective defined contribution (CDC) schemes are a new type of pension scheme in the UK. Sometimes also referred to as Collective Money Purchase Schemes, CDCs were introduced by the Pension Schemes Act 2021.

The Royal Mail Collective Pension Plan is the only CDC scheme currently authorised by the Pensions Regulator. It launched on 7 October 2024.

What types of pensions exist in the UK?

There are two main types of pension scheme in the UK:

• Defined benefit schemes pay a promised pension which is based on factors such as salary and length of service. A sponsor, which is usually an employer, guarantees the promised benefits are paid. The pension provides an income for life and may also include a retirement lump sum.
• Defined contribution schemes do not provide a guaranteed pension and instead provide people with a pot of money they can use in retirement. The value of the pension pot can increase or decrease depending on factors, including investment returns and contributions made.

How are CDC schemes different?

In a CDC scheme, both the employer and employee contribute to a collective fund. Like a defined benefit scheme, the collective fund pays scheme members an income in retirement. However, unlike in a defined benefit scheme, the employer does not guarantee the pensions paid by the scheme.

CDC schemes provide a target pension which is not guaranteed. The fund is managed collectively, unlike in defined contribution schemes where people build up their own pension pots. If the scheme is under (or over) funded, then members’ pensions can be decreased (or increased) accordingly.

Future policy development

Currently CDC schemes are only available to single employers. The government has consulted on proposals to extend the CDC market and plans to legislate for multi-employer CDC schemes in 2025.

What are the advantages of CDC schemes?

The main advantages of CDC schemes are seen as:

• Retirement in a single package: Like in defined benefit schemes, members of CDC scheme both build up (accumulation) and receive a pension (decumulation) in the same scheme.
• An income without a risk premium: As CDC schemes do not guarantee an income, they do not have the additional cost of securing that guarantee.
• Longevity risk sharing: People managing their own pension pots risk underspending (dying with unused funds) or overspending (running out of money). CDC schemes reduce these risks by paying pensions based on average life expectancy across the scheme’s members.
• Investment strategy: It is argued that CDC schemes can take a longer-term investment strategy than defined contribution schemes because they have a mix of members – some still contributing and building up their pensions and other receiving a pension income from the scheme.
• No continuing liability for employers: CDC schemes allow employers to offer a pension scheme, that provides an income in retirement like a defined benefit scheme, without needing to further fund the scheme if it does not have enough assets to pay the pensions it has promised.

What are the disadvantages of CDC schemes?

The main disadvantages of CDC schemes are seen as:

• Falling incomes: Pensions in CDC schemes are not guaranteed which means that the pensions paid to members can fall.
• Communications: CDC schemes are more difficult to explain than defined benefit schemes (which pay a promised benefit) or defined contribution schemes (where a saver builds up a pension pot).
• Intergenerational risks: There is a perceived risk of CDCs having the potential for generational unfairness. For example, if funds contributed by an earlier generation are used to pay higher pensions to a later one or if a later generation needs to replenish funds used by an earlier one. This is seen as less of an issue for CDC schemes in the UK due to the way schemes are required to be designed.
• Some members will be worse off: A consequence of longevity risk is that those who die younger effectively subsidise the pensions of those who live longer. This means that some members may be worse off than if they were in a defined contribution scheme with their own pension pot.