Dear Friends
Defined Benefit Superannuation – to give it up would be foolish – or would it?
Receiving a ‘guaranteed’ payment every fortnight, much like a salary, is very attractive to retirees – and many older super funds are set up this way. However, as I have been advising clients for decades, it is what goes on in the background that can have a significant impact on your medium to long-term wealth, your income and what you leave behind.
You may have heard of Defined Benefit (DB) super. Broadly speaking, the retirement benefit is calculated by a predetermined formula, usually a multiple or percentage of final salary (generally averaged over 3-5 years) at retirement. During employment, member contributions are pooled together with other defined benefit members' contributions and invested together. Employer contributions are calculated in accordance with the actuarial assumptions required to fund the final benefit and are likely to be higher than the current rate of Super Guarantee.
Current or former public servants who hold these retirement rights will often say “only a fool would give up their DB.” However, there are valid arguments for rejecting this maxim, given that there are some significant disadvantages in the DB system when compared to taking a payout (at least in part) and rolling it into an Account Based Pension (ABP).
Can DB Super keep pace with the real cost of living?
Inflation devalues what you receive over time. DB pensions are generally indexed to CPI, around 2-3% in normal times, but they rarely keep pace with the real cost of living – which is more accurately measured by Average Weekly Ordinary Time Earnings (AWOTE).
On average, over the last century the stock market grew by 7.2% annually, much more that CPI and AWOTE – compounding to produce a massive difference over time!
What about inheritance flexibility and access to capital?
If you are single, your DB benefit will expire when you do. There are no residual benefits on the death of a member.
If you are partnered, usually no more than two-thirds of your DB pension will be paid for the life term of your surviving partner. There are no further benefits, capital or income, when that partner dies.
In the case of an ABP, a surviving partner is eligible to receive 100% of the ongoing pension payment. The remaining cash after the last survivor dies, less the Death Benefits Tax of 17.5% on the taxable component (if you have not implemented a Cash out and Re-contribution strategy) will pass to your estate. That means anything left can go to the people or causes you include in your Will – not to the government, or to other DB fund members.
From time to time, parents and relatives with a robust ABP balance might want to help their children with a home deposit to get them on their way in life, or there may be significant medical or educational costs the family must bear. An ABP will allow access to tax free lump sums from your own money at any stage. There is no capital access available via a DB pension.
Seek independent advice
It is always difficult to know what to do when making decisions which can fundamentally alter the trajectory of your retirement. Defined Benefit funds are very good for the ultra-conservative retiree who is not bothered by returns and flexibility, however everyone should seek independent advice before making a binding decision – as I did when I left the Federal Public Service.
I recently met with a new client couple with DB pensions, and who provided me with this ‘Firstlink’ article “How to fix the Commonwealth Super Scheme” 8 January 2025. It confirms what I have been telling my clients since becoming a financial adviser in January 1997 (ten years and two weeks after starting my career at the ATO).
Before writing this edition of eGrow, I revisited the position of two of my favourite retirees, Damian and Dave. You may remember them from an earlier eGrow (see the original article here). Following my advice (based on their goals and financial situation) they each cashed out a lump sum – as an alternative to taking a 100% DB pension – to invest in an ABP.
The result: a) a part DB pension providing a ‘guaranteed for life’ income component, and b) an ABP providing tax-free income, investment control, capital access and inheritance flexibility. A ‘best of both worlds’ scenario!
I’m also delighted to report that over time, Damian and Dave have been receiving significantly higher net income, with the of payment minimal tax (arising only from the retained DB pension) than they would have been receiving with a DB pension only strategy.
As well as covering their living costs, they have drawn down lump sums for some glamorous annual holidays and assisted a child with a deposit on her home. Their ABP balance is essentially the same as when they retired. Their experience with a part DB pension and an ABP combination has been so much better than a 100% DB pension. At the end of their lives, their family and favourite causes will be the beneficiaries of their tax-free nest-eggs. (Damian and Dave also accepted my advice to implement a cash-out-and re-contribution strategy).
And one more thing
Over the last 12 months or so I have been reminding everyone to be on guard against scammers and to follow the Federal Government’s scam watch: http://www.cyber.gov.au/protect-yourself
Don’t forget to stay scam smart. If something seems too good to be true, it probably is.
One of the layers of security our clients have is the personal relationship with their adviser and our team. We recognise voices, we know the individuals, we are business ‘friends.’
As always, if I or any of the team can be of assistance, please don’t hesitate to reach out on (08) 8130 5130 or via email to admin@marinisgroup.com.au.
Yours sincerely
Theo Marinis CFP®, B.A., B.Ec., CPA., MCIFAA
Financial Strategist
Authorised Representative
