Labour brings fresh support to collective savings

Coverage this morning of the speech on pensions by Rachel Reeves, the shadow work and pension secretary, focused on the extension of auto-enrolment to 1.5 million extra workers. But in the long-run the more significant announcement might prove to be her backing for plans to allow collective pensions in the UK. This has the potential to result in a major shift in the UK’s pension landscape.

Ambitious reform is urgently needed. The proposals announced by the Chancellor in March’s budget  offering savers far greater freedom at the point of retirement may sound attractive, but for most people, greater flexibility won’t mean a good standard of living in retirement.

The reality is that even those who save under auto-enrolment across their entire working lives only have a one in two chance of a decent income in retirement. And for women in particular the outlook is bleak, as they are hit by a triple-whammy of lower lifetime earnings, career breaks around parenthood and a longer life expectancy.

So this morning’s news that Labour will back the legalisation of collective pensions in the UK is very welcome. Following Pensions Minister Steve Webb’s announcement in January that he wanted to see collective schemes in the UK, this cross-party support means collective defined contribution (CDC) schemes look increasingly likely to be a reality for savers.

But what are they and why do we need them?

Collective pension schemes are common Denmark, Holland, the US and Canada. They allow those in a pension scheme to contribute into a shared ‘pot’, which keeps their finances invested longer, and offers an income in retirement directly from this pot – cutting out the annuity process altogether.

Why should they be introduced in the UK?

First, by keeping costs down and being able to invest more in risky assets, collective schemes by and large offer a far higher income in retirement than individual DC schemes. Various models, including work for the government consultation, put income in retirement (at least) a third higher. That would mean a crucial income uplift for pensioners, without asking savers to pay a penny more.

Second, IPPR research has shown widespread public support for collective savings. While in some areas people value the ability to make individual customer-type choices, the immensely tricky, jargon-filled pension landscape isn’t one of them. Instead, the public showed support for default collective schemes, where the risks and rewards inherent in DC pensions were shared. People didn’t just think they would do better in these schemes, they thought they were fairer too.

Third, collective pensions are more predictable than individual pensions. By sharing risks and rewards, the very high and very low performing possibilities are cut away, so savers get a more reliable sense of what they’re likely to get in retirement.

But are collective schemes too good to be true?

There are some downsides; no pension scheme is without risk. The biggest issue for the collective saver is the possibility that their income in retirement could drop. The RSA, using Aon Hewitt modelling, identified three moments since 1930 when income in retirement would have had to be cut if CDC was the norm: in 1931/32, 1940/41 and 1952/53. On average, cuts would have been around 7%. However, cuts would have been to a pension income that started higher and incomes would have gone up again a few years later. But this isn’t an insignificant risk, and the current removal of condition benefits in the Netherlands shows the importance of warning savers of this possibility.

There are other issues that will require careful consideration. As collective savers share risks and rewards across generations there needs to be oversight and strategies to make sure one generation doesn’t do better at the cost to a future generation, given the rise in life expectancy and the impact of future medical innovation.

And there are questions about how to introduce the first scheme into the UK: who should offer it; how it can get to scale (which is necessary to improve returns to savers); what its relationship to government might be; and how it could cope with rising life expectancies without compulsory contributions.

There are no easy answers to these questions, and Labour is right to introduce a taskforce to think the issues through carefully. But if Labour and the other major parties are willing to work together, to offer a long-term, well-managed strategy for having a collective scheme in the UK, there would be public appetite and could be real benefit to future pensioners.

Collective pension schemes could be the next major step in revolutionising pension savings in the UK.

Imogen Parker is a Research Fellow at IPPR