All this gives the CDC scheme a cost advantage over retail DC pensions, such as personal pensions and self-invested personal pensions, where annual charges can be as high as 2 per cent of total funds.
CDCs target an income that increases throughout retirement
The CDC scheme targets an income that increases every year, aiming in the long term to keep pace with the cost of living.
In contrast, more than 90 per cent of annuities are purchased on the basis of a level pension, which will never increase from its initial level.
In its analysis of income drawdown, the FCA found that 40 per cent of plans are being drawn down at a rate of 8 per cent a year or more today, which suggests that they will, over the long term, need to reduce rather than increase their monthly income withdrawals.
The increasing retirement incomes provided by CDC mean that more of the payments are weighted to later in life, and so the investment horizon is longer.
Simple rules of cash flow management apply here, and while annuity providers, or drawdown clients using potting strategies, will be garnering up cash from day one to pay out pensions, the CDC scheme will be taking a longer view.
This increases the range of investments available to the CDC, and with a wider range we can expect investment managers to deliver higher returns.
So, now that we have established where that outperformance will be coming from, in the interests of balance it is worth bringing together some of the key drawbacks of decumulation CDCs.
The CDC pension can go down
CDC schemes target an increasing pension, and in most years the results of the annual valuation will be to adjust the rate of increase.
If a scheme that had been targeting a 3 per cent annual pension increase has a bad year and investment values fall by, say, 15 per cent, its trustees might declare a lower annual increase of 2 per cent for future years.
Pensions would still be increasing, but more slowly than before. It is only extreme adverse experience that would lead to a reduction in nominal levels of benefit.
It might be appropriate for a CDC scheme to ask a prospective member, 'how would you cope if your pension income was reduced by 10 per cent?' Those who cannot tolerate this level of loss might be best advised not to choose a CDC to fund their retirement.
However, by the same token it might also be appropriate to ask those contemplating buying a level annuity at retirement how they intend to cope over the duration of their retirement with increases in the price of the goods and services they currently enjoy.
