What does a Collective Defined Contribution (CDC) Plan entail?

Collective Defined Contribution (CDC) Plan: Definition

A Collective Defined Contribution (CDC) plan, also known as a target benefit or defined ambition plan, is a retirement savings scheme available in the United Kingdom. This plan pools contributions from members, collectively investing them to generate income in retirement. Unlike traditional defined contribution plans, where members manage individual portfolios and risk, a CDC plan spreads risk across all members.

The main objective of a CDC plan is to offer a target or “ambition” income during retirement, rather than a guaranteed sum. The income members receive is influenced by investment performance and the longevity of plan participants.

In a CDC plan, retirement benefits are seen as an annual income, akin to a defined benefit pension. However, this income is not guaranteed and may vary based on factors like investment performance and actuarial considerations.

How Collective Defined Contribution (CDC) Plans Work

A CDC plan is a novel pension scheme in the U.K., blending features of defined benefit and defined contribution plans. Contributions are pooled and invested collectively to deliver a sustainable income level in retirement, resembling a defined benefit scheme.

Employers and employees both contribute to a CDC fund for retirement income. Unlike defined benefit plans, employers are not obligated to guarantee scheme benefits. CDC plans provide a target pension based on factors such as salary, service length, and contribution rate, with adjustments based on the fund’s financial status.

If assumptions regarding investments or participant longevity are inaccurate, benefit levels may be adjusted. Members are provided with a retirement income target, rather than a guarantee, in a CDC plan.

By combining funds from multiple participants, CDC plans benefit from economies of scale, lower costs, and more efficient investment strategies compared to individual plans.

Contributions into a CDC plan are pooled and invested collectively to provide a targeted income level during retirement. Each member receives a share of the fund based on their contributions.

Types of Collective Defined Contribution (CDC) Plans

CDC plans can be open or closed to new participants. Open plans accept new entrants and ongoing contributions, sharing risks and rewards among all members. Closed plans do not accept new entrants, focusing on managing assets and ensuring stable retiree income.

CDC plans can also be single-employer or multiemployer. Single-employer plans are sponsored by one employer, while multiemployer plans involve multiple employers within the same industry, possibly extending to self-employed or other worker groups.

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

CDC plans differ from traditional DC plans in terms of contribution management, investment, and benefit calculation and distribution.

DC plans involve individual member accounts, investment choices, and risk management, with retirement benefits tied to account performance. In contrast, CDC plans pool contributions and returns, distributing pensions based on factors like salary and service length.

CDC plans can be more challenging to administer due to shared risks and complex benefit calculations, contrasting with the individual focus of DC plans.

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

CDC plans offer risk pooling, reducing individual risk exposure and potentially providing higher returns through shared investments. They aim to deliver a stable retirement income, facilitating financial planning for retirees.

However, CDC plan incomes can fluctuate based on investments, making retirement planning more uncertain than DB plans. They are also more complex to manage and understand, lacking individual investment control, which may not suit all members.

CDC Plan Pros and Cons

Pros

• Risk pooling reduces individual investment and longevity risk.

• Collective investment may offer lower fees, a wider investment range, and potentially higher returns.

• CDC plans aim to provide a predictable retirement income.

Cons

• Retirement income can fluctuate, unlike DB plans.

• CDC plans are more complex and lack individual investment control.

• Members do not have autonomy over their investments or risks.

• Longevity risk sharing may impact some members compared to individual DC schemes.

Starting a Collective Defined Contribution (CDC) Plan

Establishing a CDC plan requires knowledge of regulations, member demographics, and investment objectives. Designing the plan, setting contribution rates, and defining benefit levels should involve consulting with financial, actuarial, and legal experts for compliance and success.

To initiate a CDC plan in the U.K., employers or groups must seek authorization from The Pensions Regulator, meeting specific criteria for fitness, scheme design, and financial stability. The application process involves an application fee.

Authorized CDC schemes undergo ongoing supervision by The Pensions Regulator, adhering to rules on governance, funding, valuation, and administration.

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

The criteria for joining a CDC plan in the U.K. are evolving, especially for multiemployer schemes. Typical requirements for single-employer schemes include authorization by The Pensions Regulator, employment under the sponsoring employer, agreement to participate, and meeting age and service criteria.

• The employer must be authorized by The Pensions Regulator.
• The employee must have an employment contract.
• The employee must agree to contribute to the fund.
• Age and service conditions must be met.

Requirements may vary by scheme type, potentially accommodating self-employed individuals and enabling opt-outs or transfers under specific circumstances.

What Is an Example of a Collective Defined Contribution (CDC) Plan?

What Is the Difference Between a Defined Benefit (DB) Plan and a Defined Contribution (DC) Plan?

Is a Collective Defined Contribution (CDC) Plan the Same as a Pension?

The Bottom Line

CDC plans present a unique retirement solution, combining elements of DC and DB plans. They offer potential returns and risk mitigation via sharing but lack income guarantees.

Consult with professionals when considering a CDC plan.