With Queen Elizabeth’s “Royal Assent,” the United Kingdom recently adopted groundbreaking pension legislation allowing the creation of Collective Defined Contribution (CDC) pension plans.
Research shows these “pooled” plans have the potential to generate substantially better retirement income. In the wake of passage of the SECURE Act of 2019 in the US, strong bipartisan support remains in Congress for additional reforms to expand access to savings and support lifetime income. It’s time for Congress to consider allowing CDC plans as options in the U.S.
A CDC plan combines elements from defined benefit (DB) plans and defined contribution (DC) plans. One might think of it as a DB plan without the plan sponsor guaranty. Like a DB plan, it provides an “income for life,” which is what most people want when they save for retirement. Of course, employees prefer the classic DB plan with a sponsor’s guaranty to a CDC plan, because the DB plan guarantees, while the CDC plan can only target, a specific income. However, fewer employers in the U.S. are willing or able to take on or carry the long-term liabilities inherent in a DB plan. With this reality, the alternative for most workers is a DC (usually a 401(k)) plan that, in most cases, does not offer any type of lifetime income option. For this reason alone, a CDC plan has the potential to provide a more-reliable source of income in retirement.
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In most DC plans today, individuals receive a lump-sum check upon retirement not an income for life. Individuals in a DC plan have to decide if their portfolios should be invested more conservatively upon retirement. Plan participants must function as their own chief investment officer, chief actuary, and chief risk officer, even though most have no training in any of those areas and have to figure out how to manage their savings to last a lifetime.
In a CDC plan, a professional investment team chooses an investment policy and asset allocation; actuaries focus on liabilities; and risk officers assure that investments are properly diversified and do not take too much risk. The investment staff is not only functioning on behalf of one 65-year-old individual, but also on behalf of thousands of people who are much younger. This allows the investment portfolio to remain in longer-term, higher-return assets.
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But by far the most important thing a CDC does is to pool longevity risk — the risk of outliving retirement savings. No one knows how long they will live, so they do not know how much of their savings they should draw down from month to month. But actuaries predict average life expectancy, understanding that some people will live longer than others, and therefore can use the power of pooling to make sure each person receives income for life.
Studies show that these plan design features produce significantly better results for participants. One example is a study by the Royal Society for Arts (cited by Parliament in its deliberations), which showed CDC plan outcomes to be 37% better than outcomes in DC plans.
One of the weaknesses of CDCs is that the income outcome is not certain. In a DB plan, the plan sponsor’s benefit is guaranteed. In a CDC plan, the benefit is not fixed and guaranteed for life. But it is wrong to compare a DB plan to a CDC plan.
Workers and policy makers are not being asked to choose between a DB or CDC plan; they would choose between a DC plan and other options, such as a CDC plan, that could be a better option and that sponsors could manage.
This was clear in Britain’s process. The Royal Mail wanted to change its pension plan, and the labor union recognized the superiority of a CDC plan. Labor wanted workers to have income in retirement. They understood that, if the likely outcome for their participants in a CDC plan is 37% greater than the outcome in a DC plan, then even without any guaranty, the CDC is a better plan than other non-DB alternatives.
The bipartisan SECURE Act of 2019 began to move the U.S. in the direction of pooling with the creation of “pooled employer plans” (PEPs), and future reforms that build on this initial effort should not only do more to make PEPs and lifetime income solutions attractive but take it a step further to encourage CDC plan options.
Britain took a few years to develop and pass this historic reform. It required cooperation from labor and from employers; from conservatives and liberals; and from think tanks, academics, and actuaries before the law received Royal Assent from Queen Elizabeth in February. In the U.S., we will not need the assent of a monarch, but we will need the same kind of cooperation from all participants and stakeholders to improve retirement income outcomes for today’s DC retirement system.
Charles E.F. Millard is the former Director of the U.S. Pension Benefit Guaranty Corporation; David Pitt-Watson is a Visiting Fellow at Cambridge University’s Judge Business School; and Angela M. Antonelli is a Research Professor and the Executive Director of the Center for Retirement Initiatives (CRI) at Georgetown University. This opinion piece is based on a research paper recently published by the Georgetown CRI, and represents the views of the authors and not their organizations.
