WTW proposes four replacement options for ‘broken’ DC pensions

LONDON, October 9, 2024 — In a white paper published today, WTW calls on employers to look beyond just repairing ‘broken’ defined contribution (DC) pension provision. The paper proposes four ways of replacing DC pensions with designs that could help employees achieve better outcomes without employers having to shoulder the risks associated with traditional defined benefit plans.

Rash Bhabra, head of WTW’s Retirement practice in Great Britain, said:

“With every year that passes, employees in most of the private sector are becoming more reliant on DC pensions to satisfy their income needs in retirement.

“DC can be made better, and there is rightly a lot of attention on this, beyond just increasing contributions: schemes can be bigger and more efficient; they can invest more widely and hold growth assets for longer; and they can give employees much more support at retirement. We welcome the sense of urgency on this.

“But we should also ask whether we can do better than DC: in its current form, DC is broken, and we should consider whether it is better to replace it rather than repair it. What individuals really need is retirement income. Few employers want to go back to anything like a traditional final salary scheme. And so we are proposing other ways of providing higher retirement incomes and which avoid leaving employees with decisions that most are ill-equipped to make, such as figuring out for themselves how to stretch out their pension savings throughout their retirement.”

WTW’s paper, Reimagining pensions, outlines four replacement options for current DC, which WTW hopes will encourage further thinking about how to reimagine workplace pensions. In each case, WTW’s modelling suggests these should deliver markedly higher retirement incomes than saving in a DC pension and buying an annuity at retirement.

1. Whole-of-life Collective Defined Contribution (CDC): Such designs share risks between members and provide pension income rather than pots at retirement, at a fixed cost to the employer. Pension levels will depend on fund performance but WTW’s central projection is that, for the same contribution cost, a whole-of-life CDC pension should be around 55% higher than annuitised DC savings. While the largest employers can already adopt these designs, WTW believes more employers will consider this when regulations allow them to outsource CDC provision to a multi-employer arrangement or master trust. Royal Mail’s scheme provides a blueprint for those that might wish to follow suit.
2. DB with variable increases: As legislation allows CDC pensions to be reduced in particularly adverse scenarios, there is no reason in principle to prohibit employers from offering, for future service, new variable pensions which are DB only to the extent they are guaranteed not to fall. Indeed, some flexibility to do this already exists. This is modelled to provide an expected retirement income 35% higher than DC with annuity purchase.
3. DC pots used to buy CDC retirement incomes: The least disruptive approach for employers with existing DC plans would be for their schemes to provide a CDC retirement income option. WTW would like the legislative consultation on this to begin as soon as possible. Their modelling gives median retirement outcomes of around 40% higher than under DC with annuity purchase.
4. Variable cash balance with CDC in decumulation: Contributions would build up a cash balance ‘pot’ with targeted annual increases. Actual increases would depend on investment performance, but the pot value could not go down, providing greater certainty and less volatile outcomes for individuals than DC. The resulting pot would be used to buy a CDC retirement income. Their modelling gives median retirement outcomes of around 40% higher than under DC with annuity purchase.

All four of these designs lead to better outcomes than annuitised DC and all could play a major role in shaping the pensions landscape. WTW calls on the Government to introduce changes to legislation that allow for innovation in pension scheme designs for the benefit of UK workers, and for the pensions industry to engage fully on bringing about change.

About WTW

At WTW (NASDAQ: WTW), we provide data-driven, insight-led solutions in the areas of people, risk and capital. Leveraging the global view and local expertise of our colleagues serving 140 countries and markets, we help organizations sharpen their strategy, enhance organizational resilience, motivate their workforce and maximize performance.

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