Should I join Royal Mail’s collective pension scheme?

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The new pension Royal Mail is proposing to start in 2022 will affect me as I’ve worked there for a number of years and I’m now in my thirties.

Royal Mail will be the first in this country to move to a ‘collective defined contribution’ pension plan if it happens, though the system has been used in the Netherlands.

I have read up on CDC pensions, as pensions are something that interest me, which leaves me leaning towards the view of them being poor compared with our current plan.

Also, I believe they very much favour the older working generation (those looking to retire within 10 years), leaving my age group (those with 25-plus years to work) worse off.

From what I have read, we will struggle to recoup what people such as me have paid into the plan, and also it’s unpredictable in regards to potential returns.

Another concern is the fact Royal Mail is investing in high risk assets with the ‘pot’ which I understand will be 100 per cent in equities.

Currently the maximum we can pay in as employees is 6 per cent of salary, unless we top up with voluntary contributions, and Royal Mail inputs 9 per cent which I’m more than happy with.

With the new CDC scheme, Royal Mail is trying to make it look more attractive by saying it is upping its input to 13.6 per cent on people paying 6 per cent.

It says that on the death of an employee/ex employee their spouse will continue to receive their benefits out of the CDC pot at the expense of current Royal Mail employees.

My personal pension pot is now worth roughly £50,000.

My question is, would I be better opting out of the CDC plan and joining another pension provider where I can transfer the pot I’ve built up already, but which Royal Mail only contributes 3 per cent of salary to?

I can then choose how much investment risk I want throughout my working life and I will know I’ve got my own personal pot come retirement.

SCROLL DOWN TO FIND OUT HOW TO ASK STEVE YOUR PENSION QUESTION    

Steve Webb replies: As you know, the Royal Mail is leading the way with a type of pension arrangement which is quite common elsewhere in the world but new for the UK.

But other employers are known to be looking closely at this model so it is something which could be of relevance well beyond the Royal Mail.

The background is that until now there have been two main types of pensions.

The first is the traditional ‘defined benefit’ arrangement where the amount you get is guaranteed and simply depends on how much you earned and how long you worked.

As long as your employer doesn’t go bust, you should get a pension in line with the rules of the scheme.

The other main type of pension is ‘defined contribution’ or ‘pot of money’ where you and your employer are paying money into a pot which is invested up to your retirement.

Crucially, you have your own ring-fenced pot which is separate to the pot of any other of your colleagues.

The only thing which is ‘defined’ in advance is the amount being paid in. The pension you eventually get depends on how well the money is invested, what has happened to annuity rates and so forth.

For a member, a DB pension is very attractive.

The member simply pays in at the required rate and the cost of meeting the promised pension is then under-written by the employer.

If investments under-perform or members live longer than expected, all these additional costs have to be financed by the employer.

For this reason, many firms – including the Royal Mail – have decided that they can no longer offer this type of provision.

With an individual DC pension pot, by contrast, there are several drawbacks.

You cannot know how big your event pension pot will be, nor how much pension it will buy in retirement if you chose to buy an annuity.

Alternatively, if you decide to put your pot into a drawdown account in retirement, you are then subject to all the risks outlined above, and you also have to manage the funds over an uncertain life span.

Against this backdrop many firms no longer want to offer DB schemes, but many members may feel that they have to take too much risk with an individual DC scheme.

The Royal Mail and the Communications Workers Union have worked together to come up with a compromise known as ‘Collective DC’ or CDC for short.

You mention the Netherlands which is indeed one country which has had collective pension arrangements for many years, but what the Royal Mail is proposing is quite different.

In brief, the employer and employee will each contribute a set amount to the pension scheme.

Although the payout is not guaranteed, there is a target pension which you should hope to get. If things turn out badly – for example if the investment returns seriously under-perform – then benefits can be scaled back.

But the ‘pain’ is felt by all members – whilst future pensions may be reduced, those in retirement could see their annual increases scaled back, for example – in order to get the scheme back on track.

In some of these ‘collective’ pension schemes there have been concerns that older members have been favoured over younger ones. 

But a lot depends on the design of the scheme, and the trustees who oversee the scheme have a duty to be fair to all members. This is why, if the fund doesn’t perform well, both pensioners and workers would share the pain.

Opinions vary considerably on the merits of CDC schemes of this sort. A member would probably generally prefer a DB scheme but that may not be on offer.

Compared with an individual DC scheme where all the risk is on the individual, a ‘collective’ DC scheme may offer greater predictability.

One important advantage is that in a CDC scheme your pension lasts as long as you do – the scheme deals with the issue of your uncertain life expectancy by ‘pooling’ the risk of you outliving your money across all scheme members.

You ask whether you should opt out of this arrangement and instead choose one with another provider where the employer will only pay in 3 per cent.

Whilst I cannot give you financial advice, I would simply point out that you would have to do very well in a scheme where the employer only pays in 3 per cent of salary to get a better result than in a scheme (like the CDC scheme) where the employer is paying in over 13 per cent.

It remains to be seen if CDC schemes will take off in the UK as they have done in a number of other countries, but they may offer a valuable ‘third way’ of providing pensions which is affordable to the employer but still valuable to the member.