What Is a Collective Defined Contribution (CDC) Plan?

Collective Defined Contribution (CDC) Plan: Definition

A collective defined contribution (CDC) plan, also known as a target benefit or defined ambition plan, is a type of retirement savings plan available in the United Kingdom where contributions are pooled together and invested to provide members with an income during retirement. Unlike a traditional defined contribution (DC) plan where individual members choose their own portfolios and bear their own investment risk, a CDC plan spreads the investment risk among all the plan members.

The primary purpose of a CDC plan is to provide a target or “ambition” income in retirement, rather than a guaranteed amount. The income that a member receives is dependent on factors such as the performance of the investments and the longevity of members within the plan.

The retirement benefits in a CDC plan are treated as an annual income, similar to a defined benefit (DB) pension. However, CDC income is not guaranteed and may fluctuate based on investment performance and other actuarial factors.

How Collective Defined Contribution (CDC) Plans Work

A collective defined contribution (CDC) plan is a new type of pension scheme in the U.K. that was introduced through the Pension Schemes Act 2021. It is an alternative pension scheme design that has features of both defined benefit (DB) and defined contribution (DC) plans. Contributions are collected like a DC plan, but are pooled and invested collectively with a view to delivering a sustainable target benefit level of lifetime income in retirement, more like a DB plan.

In a CDC plan, both the employer and the employee contribute to a collective fund that provides an income in retirement. Unlike in a DB plan, the employer does not need to guarantee the benefits paid by the scheme. Instead, CDC plans provide a target pension, which is based on factors such as salary, length of service, and contribution rate. However, if the scheme is underfunded or overfunded, the income that it pays out can be decreased or increased accordingly.

If assumptions about investment performance, longevity, or other actuarial factors prove to be inaccurate, then the level of benefits will be adjusted. This means that in a CDC plan, members are not provided with a guarantee, but rather a target for what they can expect to receive upon retirement.

Because they pool funds from several plan participants, CDC plans can benefit from economies of scale, lower administrative costs, and more efficient investment strategies than individual DC plans.

Types of Collective Defined Contribution (CDC) Plans

CDC plans can be either open or closed to new participants. Open CDC plans accept new entrants and ongoing contributions. In these plans, risks and rewards are shared among all members, regardless of their age or tenure in the plan. Closed CDC plans do not accept new entrants or ongoing contributions. The focus is on managing the assets and liabilities of existing members and ensuring stable income to retirees.

CDC plans may also be either single-employer or multiemployer. A single-employer CDC plan is sponsored by just one employer for its own employees. A multiemployer CDC plan is instead sponsored by more than one employer, usually in the same industry or sector, for their collective employees. Multiemployer CDC plans may also be open to self-employed individuals or other groups of workers who do not have access to an employer-sponsored pension scheme.

Collective Defined Contribution (CDC) Plan vs. Defined Contribution (DC) Plan

The main differences between a CDC plan and an ordinary DC plan are who contributes and manages the investments, and how the benefits are calculated and paid.

In a DC plan (sometimes known as a money purchase pension scheme), each member has their own individual account that accumulates contributions and investment returns over time. Each individual member is responsible for choosing their portfolio allocation and managing the investment risk. At retirement, the member can use their account balance to buy an annuity, draw down income, or take a lump sum. The amount that they receive depends on how much they have saved, how well their investments have performed, and how long they expect to live.

In a CDC plan, on the other hand, there is no individual account or portfolio for each member. Instead, all contributions and investment returns are pooled together in a collective fund. The fund pays out pensions to members based on a formula that takes into account their salary, length of service, and contribution rate. The amount of pension that they receive depends on how well the fund has performed and how many members are in the scheme. In general, CDC plans are more complex to administer than DC plans due to the pooling and sharing of risks and the calculation of benefits.

Advantages and Disadvantages of a Collective Defined Contribution (CDC) Plan

CDC plans come with the considerable advantage of risk pooling. Shared risk among all members means that individual investment and longevity risk is significantly reduced, offering a measure of security. The collective nature of these plans allows access to a broad range of investment opportunities, which may lead to potentially higher returns than in individual investing. Moreover, CDC plans aim to provide a consistent income during retirement, providing members with a predictable income stream that many find easier to manage than a lump sum.

On the flip side, the income provided by CDC plans can be unpredictable, as it is subject to fluctuation based on investment performance and other factors. This can make financial planning for retirement more challenging than defined benefit (DB) plans, which guarantee a specific retirement income. CDC plans are also more complex to understand and administer, which can be a barrier for some individuals and organizations. Finally, individual control over investments is not possible in CDC plans, which might not suit members who prefer to manage their own investment strategies.

Starting a Collective Defined Contribution (CDC) Plan

Setting up a CDC plan requires a comprehensive understanding of the regulatory environment, the demographics of the potential members, and the investment goals. You will need to design the plan, decide on contribution rates, and set a target benefit level. It is recommended to consult with a qualified financial advisor, actuary, and legal professional to ensure compliance with regulations and to achieve the desired outcomes.

To start a CDC plan in the U.K., an employer or a group of employers must apply for authorization from The Pensions Regulator (TPR). The application process involves meeting certain criteria for fitness and propriety, systems and processes, member communications, continuity strategy, financial sustainability, and sound scheme design. The standard application fee is £77,000.

Once authorized, CDC schemes are subject to ongoing TPR supervision and reporting. They will also need to comply with certain rules and regulations regarding governance, funding, valuation, benefit adjustments, disclosure, and administration.

Eligibility Criteria for Participation in a Collective Defined Contribution (CDC) Plan

The eligibility criteria for participating in a CDC plan in the U.K. are not yet fully defined, as the regulations for multiemployer CDC schemes are still under consultation. However, based on the draft regulations for single-employer CDC schemes, some of the possible requirements are:

• The employer must be authorized by The Pensions Regulator to operate a CDC scheme.
• The employee must be a member of the employer’s workforce and have an employment contract with the employer.
• The employee must agree to join the CDC scheme and make regular contributions to the collective fund.
• The employee must meet certain age and service conditions, as specified by the scheme rules.

These requirements may vary depending on the type and design of the CDC scheme. For example, some CDC schemes may be open to self-employed individuals or other groups of workers who do not have an employer-sponsored pension scheme. Some CDC schemes may also allow members to opt out or transfer out of the scheme under certain circumstances.

The Bottom Line

Collective defined contribution (CDC) plans offer an innovative solution to retirement planning, merging aspects of both defined contribution (DC) and defined benefit (DB) plans. They provide the potential for higher returns and spread risks among all members. However, they can be complex and do not guarantee a fixed income in retirement.

Always seek professional advice when considering setting up a CDC plan.