Learning About Collective Money Purchase Schemes
Collective money purchase schemes are a newly introduced option in addition to defined contribution and defined benefit schemes. These are most likely to be tested in specialist pension papers such as R04 and JO5, but could also come up in more general financial product exams such as LP2 or pension transfer exams like AF7.
For as long as most of us can remember, there have been two basic types of occupational pension scheme available to workers. You can basically have a defined benefit scheme or a defined contribution one.
The former means that the member is paid a lifetime pension of a certain percentage of their final salary (or career average earnings) from their retirement date. The latter simply means that both member and employer pay into a fund-based pension pot. The risk in terms of investment returns, what the fund will buy at retirement and how long it will need to last is for the member to deal with. More recently, certain hybrids have sprung up, such as targeted defined contribution schemes and cash balance schemes, but those are the main options.
Collective Money Purchase Scheme
The Pension Schemes Act 2021, however, legislated for the introduction of a new option, the collective money purchase (previously referred to as collective defined contribution) scheme. This type of arrangement has been available in other countries for quite some time and has been mooted in the UK for quite a while. Primary legislation to facilitate its introduction was first enacted in 2015, though its conclusion has been delayed, largely due to more pressing political matters. Now, however, it is set to become a reality, with The Pensions Regulator (TPR) laying out its new code of practice for the authorisation and supervision of such schemes before Parliament on 9 June 2022 in the form of the Occupational Pension Schemes (Collective Money Purchase Schemes) Regulations 2022.
TPR has announced that it intends to begin accepting applications from trustees to operate a collective defined contribution scheme from 1 August 2022. The Royal Mail has indicated an intention to apply and is envisaged to become the first organisation to formally establish their collective money purchase scheme, which is intended to target a pension of 1/80th of pensionable pay for every year of service.
What is a Collective Defined Contribution Scheme?
So what is a collective defined contribution scheme and how does it differ from a normal defined contribution scheme? The essential elements of a defined contribution scheme are still there, with the employer required only to make contributions on behalf of themselves and the member. The contributions, however, will target a certain level of benefit (the ‘target pension’), which is expected to be provided based on employer and employee contributions and the target return.
The target pension will be adjusted in line with inflation and will be paid directly by the scheme. The key point to take into account is that the pension is only a target and there is no liability to the employer if the fund available at retirement is not sufficient to meet it. Where there is a scheme deficit, the target may have to be revised and annual increases may be revised, even for pensions which are in payment. Like a defined benefit scheme, the funding position will require a regular actuarial valuation. Unlike a defined benefit scheme, however, it will not be eligible for the Pension Protection Fund (PPF).
The proposed plans differ from a standard defined contribution scheme in that members do not have individual funds and do not choose the assets in which they invest. Rather, the contributions are pooled within a single fund within the schemes, which are trust-based and can be set up by a single employer or a group of connected employers.
The benefits to the employees arise in the form of a greater degree of certainty than with a standard defined contribution scheme. Risk will be born collectively in terms of investment and longevity, which means a greater degree of certainty and stability. Build-up of benefits is more certain and members can be expected to receive a higher average pension than they would by purchasing an annuity from a pure defined contribution scheme.
Members do, however, retain the right to transfer out of the scheme to purchase an annuity or utilise flexi-access drawdown in the same way that they would with a pure defined benefit scheme. The FCA has yet to make clear the exact advice process that it would expect to be followed in advising on such a transfer.
It remains to be seen how successful these schemes will be, or to what extent they will ‘catch on’. But depending on your point of view, they could prove to be a useful planning opportunity or a serious regulatory headache for your average pensions adviser.
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