DEFINING YOUR DEFINED BENEFIT FUND
Defined benefit funds are superannuation funds where members' contributions are pooled instead of being allocated to particular fund members. More common amongst superannuation funds for public sector employees, the benefits paid out of defined benefit funds are determined based on a person's employment details such as their salary or length of employment. This means the fund takes on the risk and you are entitled to a consistent retirement income stream regardless of market performance.
Many of the funds that have been established since superannuation became a compulsory workplace entitlement for employees are accumulation funds. Defined benefit funds, however, have been around since 1862. Importantly, this doesn't mean these funds are outdated. In some cases, defined benefit funds can provide more benefits to members than an accumulation fund. We've answered some common questions about defined benefit funds below.
Who is entitled to receive defined benefits?
Defined benefit funds are predominantly for public sector and some corporate employees. A lot of these funds are now closed to new members. Some of the biggest defined benefit funds in Australia include TelstraSuper, Qantas Super, Rio Tinto Staff Super Fund, Commonwealth Superannuation Scheme Fund (CSS), UniSuper and Gold State Super.
What happens in the event of death of a member?
If a member who receives income from a defined benefit fund dies, the income stream will revert to a death benefit income stream. This death benefit income stream will be a percentage of the member's income stream. From 1 July 2017, the transfer balance cap of $1.6 million was enforced. This means that a death benefit paid after this date can't be retained in the accumulation phase and must be paid as a death benefit income stream or as a lump sum.
What are the different defined benefit options?
Upon retirement, a member's benefits will be paid as a lump sum, lifetime pension or a combination of these two options. For example, after 25 years of membership in a defined benefit fund, you could decide between the following retirement benefits:
· a lump sum worth five times your annual salary; or
· a lifetime pension as a monthly payment worth 75% of your final salary.
Which defined benefit option should you choose?
You'll need to consider your retirement goals and objectives to determine which defined benefit option is right for you. While a lump sum payment may be tempting to pay off debts, the increased life expectancy of people since defined benefit schemes were established (most in the early 1900s), means you could comfortably service any outstanding debts such as your mortgage, plus live a comfortable lifestyle with the lifetime pension option. Of course, other factors will come into your decision such as your age and overall financial position, so you should discuss your situation with a financial planning professional before you make any decisions about your retirement income.
What are the pros and cons of each defined benefit option?
Each defined benefit option has pros and cons. Perhaps the biggest potential benefit of choosing a lump sum payment is the freedom you have in deciding how that money is used. For example, you could invest the capital elsewhere, make some big purchases, and pay off outstanding debts. The major con of choosing the lump sum payment option is the tax implications. If you withdraw your lump sum before your preservation age, it will be taxed at 22%, including the Medicare levy. Further, once the lump sum is paid, it's no longer considered superannuation, so you may incur new taxes if you invest the lump sum elsewhere.
The key benefits of choosing the lifetime pension include consistent tax-free income if you start drawing a lifetime pension after your preservation age. With today's increased life expectancy, a lifetime pension may also be a more reliable form of income if you're in good health and expect to live well into your twilight years.
Choosing the right superannuation products is important, so seek the advice of a qualified financial planner to understand the right defined benefit fund for you.