Defined Benefit Super vs. Accumulation plans

Defined Benefit Superannuation

A Defined Benefit Super Fund is an older type of superannuation fund generally available to employees of the public service sector and some large corporate companies. Majority of these funds are now closed to new employees.

The value of your retirement benefit is defined by the fund rules and usually depends on:

  • The amount of money that gets paid in by you and your employer
  • The length of time you have worked for your employer
  • Your salary before you retire

Defined Benefit funds are often generous and low-risk. If your fund’s investment performance is poor, the fund and your employer are still obligated to deliver the benefits due when you retire. So long as your employer and the fund can afford that, your investment risk may be limited to what’s earned on any personal contributions. Because of the fund’s obligations, you often have very limited choice in how your superannuation dollars are invested.

During severe market downturns, some defined benefit funds can reduce the benefits payable across all members, including pension payments, in order to be able to continue to meet the fund’s obligations.

If you leave your employer, you may be forced to keep your money in that fund, possibly at low rates of return, until you retire.

Accumulation Superannuation

An Accumulation Super Fund is the most common type of superannuation offered to employees today. The value of your retirement benefit depends on:

  • The amount of money your employer and you contribute to the fund
  • How much your fund earns from investing the money, after deducting costs and taxes. Investment earnings are added to your account, and investment losses are deducted.
  • At retirement, you can take your account balance as a lump sum, start an account-based pension or a combination of the two.

In these funds, you take the risks and get the rewards from your fund’s investment performance.

You have the choice of how you wish the funds to be invested or you can leave it up to the fund to decide by choosing their “default” option.

Pension Options – Defined Benefit Funds

At retirement, you generally have the option to take a life-time pension, lump sum payment or combination of life-time pension and lump sum – please check with your specific fund as they may have different rules that apply.

Below we have summarised the benefits and risks of each of these options.

Option 1: Life-time Pension

Benefits:

  • You don’t need to worry about how to invest the funds. Your final benefits are not reliant on investment returns and are generally guaranteed by the Defined Benefit Fund.
  • Your pension is determined for you (based on a formula) and is indexed to inflation for the rest of your life.
  • Your spouse may receive a proportion of your pension after your death – this is optional and depends on your Defined Benefit Fund rules.

Risks:

  • You will not have access to the capital once converted to a life-time pension.
  • You cannot vary the amount of pension you receive.
  • You need to check with your fund provider what happens to the benefits after your death. Different funds have different rules – for example:
    • If you die, payments cease and any capital remaining is forgone and kept by the Defined Benefit fund;
    • A smaller pension may be paid to your spouse after your death; or
    • If you and your spouse die after 10 years, the remaining capital is forgone and pension payments cease.

Option 2: Lump Sum Payment/Rollover

Benefits:

  • You can pay off any debts you have and rollover the remaining funds to start an account-based pension of your choice.
  • You have access to the remaining capital whenever needed.
  • You can choose the amount of pension you wish to receive (however there is minimum amount you must take depending on your age).

Risks:

  • The balance of the account is subject to market volatility and is not guaranteed.
  • You must choose how to invest the funds (we can help you with this decision).
  • The balance of the account will count as an asset for Centrelink purposes.

Option 3: Combination of Life-time Pension & Lump Sum

You could take part of your benefit to pay off any debts or invest the funds for future uses and keep the remaining funds to start a life-time pension. Some Defined Benefit funds offer this option whereas others do not – check with your fund.

Determining which option to take

In determining the most appropriate option, you need to consider the following important questions before you retire:

  • Capital – do you want to have access to your capital after starting a pension?
  • Expenditure needs – how much do you require to live comfortably in retirement?
  • Flexibillity – do you want the ability to vary the amount of pension you wish to receive each year?
  • Risk – are you able to cope with market volatility.
  • Centrelink – do you want to access Centrelink benefits?
  • Longevity – are you concerned about outliving your capital?
  • Leaving an estate – do you want to leave an estate to your family after your death?

In deciding which option to take, we can help you by determining the break-even point between taking a life-time pension or account-based pension or combination of the two.

If you are nearing retirement and would like advice in regards to your superannuation and pension options contact Prudentia Financial Planning today for a free initial consultation.