WTW is calling on employers to look beyond just repairing ‘broken’ defined contribution (DC) pension schemes and proposes four alternatives that could help employees achieve better outcomes without employers having to shoulder the risks associated with defined benefit (DB) plans.
Its white paper Reimagining pensions, published today, outlines four alternatives, which WTW hopes will encourage further thinking that could deliver markedly higher retirement incomes.
Rash Bhabra, head of WTW’s retirement practice for Great Britain, said: “With every year that passes, employees in most of the private sector are becoming more reliant on DC pensions to satisfy their income needs in retirement.
“DC can be made better, and there is rightly a lot of attention on this, beyond just increasing contributions: schemes can be bigger and more efficient; they can invest more widely and hold growth assets for longer; and they can give employees much more support at retirement. We welcome the sense of urgency on this.
DC pensions alternatives
“But we should also ask whether we can do better than DC: in its current form, DC is broken, and we should consider whether it is better to replace it rather than repair it. What individuals really need is retirement income.
“Few employers want to go back to anything like a traditional final salary scheme. And so we are proposing other ways of providing higher retirement incomes and which avoid leaving employees with decisions that most are ill-equipped to make, such as figuring out for themselves how to stretch out their pension savings throughout their retirement.”
The four DC pensions alternatives proposed by WTW are:
1. Whole-of-life Collective Defined Contribution (CDC)
Such designs share risks between members and provide pension income rather than pots at retirement, at a fixed cost to the employer. Pension levels depend on fund performance but WTW’s central projection is that, for the same contribution cost, a whole-of-life CDC pension should be around 55% higher than annuitised DC savings. While the largest employers can already adopt these designs, WTW believes more employers will consider this when regulations allow them to outsource CDC provision to a multi-employer arrangement or master trust.
Royal Mail’s scheme, launched this week, provides a blueprint for those who might wish to follow suit and yesterday (8 October) the Department for Work and Pensions launched a consultation on introducing legislation that would expand the scope of CDC pension schemes. The consultation closes on 19 November.
2. DB with variable increases
As legislation allows CDC pensions to be reduced in particularly adverse scenarios, there is no reason in principle to prohibit employers from offering, for future service, new variable pensions which are DB only to the extent they are guaranteed not to fall. WTW said some flexibility to do this already exists. This is modelled to provide an expected retirement income 35% higher than DC with an annuity purchase.
3. DC pots to buy CDC retirement incomes
The least disruptive approach for employers with existing DC plans would be for their schemes to provide a CDC retirement income option. WTW would like the legislative consultation on this to begin as soon as possible. Their modelling gives median retirement outcomes of around 40% higher than under DC with annuity purchase.
4. Variable cash balance with CDC in decumulation
Contributions would build up a cash balance ‘pot’ with targeted annual increases. Actual increases would depend on investment performance, but the pot value could not go down, providing greater certainty and less volatile outcomes for individuals than DC. The resulting pot would be used to buy a CDC retirement income. Their modelling gives median retirement outcomes of around 40% higher than under DC with annuity purchase.
All four of these designs lead to better outcomes than annuitised DC, according to WTW, and all could play a major role in shaping the pensions landscape. WTW is calling on the government to introduce changes to legislation that allow for innovation in pension scheme designs for the benefit of UK workers, and for the pensions industry to engage fully on bringing about change.
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