We know all is not well with the pension freedoms when the latest FCA Data Bulletin, published in September, tells us that over half of all pension pots accessed for the first time between October 2017 and March 2018 were fully cashed in. And most of the resulting savings end up in personal bank or building society accounts offering low interest rates.
How will the ex-holders of the 757,927 pensions so far fully cashed in since the freedoms fare 15 years from now? Particularly, those who “seized control” over seemingly life-changing amounts of money from large defined benefit-transferred pots? Only time will tell but without sound budgeting, even the largest lottery winners can end up penniless.
However, for the past month, one strong bright light in the otherwise gloomy pension savings tunnel has shone through in the shape of collective defined contribution schemes. Yes, secretary of state for work and pensions Amber Rudd backed plans for the first CDC scheme in the UK for Royal Mail workers on 18 March.
The CDC offers a clear alternative to the uber-individualistic, every-man-for-himself mantra which the pension freedoms are shot through with. Instead, CDCs promise the economies of scale which come from bringing thousands of workers’ pension savings into a single trustee-managed scheme.
The benefits of CDCs are clear: members get a transparent picture of what pension to expect, with regular payouts from their scheme. And unlike traditional final salary pension schemes, those payouts are not affected if your employer goes under.
Furthermore, you cannot over-draw on your pot, unlike income drawdown policyholders.
The first priority is to deliver on the agreement reached between management and unions at Royal Mail. As soon as the Royal Mail CDC scheme is operational and the threat of a postal strike over pensions averted, the government will be able to open up the exciting new world of CDC schemes to other players.
The great thing about CDC-based decumulation is that it delivers a fairly regular wage in retirement, something most of us are becoming used to in our working lives.
Particularly since 2008, we’ve stopped depending on our income rising significantly year-on-year.
The result is that we’re getting better at budgeting. Knowing precisely how much we have coming in means we slowly get better at managing our costs in line with virtually static monthly incomes.
So we should not be as alarmed as many were with the 2016 Money Advice Service research which found that 16.8 million people of working age in the UK had less than £100 of accessible savings.
If you think a little deeper about that statistic, it suggests the majority of workers have a finely honed ability to manage their spending accurately between pay cheques.
Watch a parent out shopping with their children and you will see it
in action, as they say: “Ask me again at the end of the month when I’ve been paid and maybe you can have that.”
What we need to deliver to many of these millions captured by the MAS research is a monthly retirement income which is predictable and will last their whole lifetime.
CDC pensions can hope to invest in the sort of real assets that long-term pension funds should hold like infrastructure projects for improving roads, bridges, schools and railways, as well as in equities and property development.
The trustees managing the CDC fund will share out the spoils in a collective manner, organising the cross-subsidy between those who live long and those who die early, spreading costs over both large and small pots, and smoothing out the short-term ups and downs of market prices. The normal commercial dynamics don’t apply in schemes managed by trustees.
While a purely profit-driven approach pressures the managers into offering the customers a little less and charging them a little more, trustees have a duty to protect the members’ interests and to ensure scheme managers are properly following the trust deed and rules.
I’ve sat in many trustee meetings and seen them spend money on members, when a purely commercial approach would have been to cut back.
However, CDC schemes still need a financial backer, despite what Royal Mail is saying on this.
The importance of having a capital adequacy buffer becomes apparent when what yesterday’s economists thought was a temporary market downturn turns out to be a permanent correction.
In these cases, CDC scheme trustees could find that they’ve reduced payments too late – as happened in the Netherlands.
In this instance, the balance can either be paid for from the capital buffer or from future new entrants.
But with a financial backer, fresh capital can be raised – averting this scenario from playing out in tough times like we saw back in 2008/09.
Of course, capital buffers have to be paid for, so the reward mechanism for the scheme funder can be built into the rules and honestly managed by the trustees.
The new sort of pension that CDC offers – let’s call it a “later life replacement income” – will be particularly suitable for those who can realistically afford one-off advice at the point of retirement, rather than ongoing advice throughout retirement.
As a one-off transaction, an adviser could help a good many people to understand whether CDC is right for them and then choose between competing CDC decumulation offerings as they come to market.
Adrian Boulding is director of retirement strategy at Dunstan Thomas