In superannuation land, there’s a really big difference between market linked accumulation accounts and accounts which are called “defined benefit” (DB) plans. I have changed my view recently in relation to DB super plans altogether and feel compelled to discuss why publicly and for the record.
Although the distinction between DB plans and market linked accumulation accounts is very important, an equally important distinction to make is within the DB category itself.
Specifically, there’s a massive (and critical) difference between DB plans which offer a guaranteed lifetime pension (DBGLP) and DB plans which only pay out a guaranteed lump sum (DBGLS).
What is defined benefit super?
Defined benefit super is a type of superannuation scheme where the retirement benefit is predetermined based on a formula, usually related to salary and years of service. This differs from the more common market-linked accumulation accounts, where the final benefit depends on investment performance.
Firstly, DBGLP plans pay a % of some closing salary amount to the member for the rest of that member’s life. In rare instances with some very old schemes, upon the members death, that ongoing lifetime pension guaranteed entitlement transfers to the members spouse for the rest of his or her life.
These plans now practically don’t exist apart from some very rare instances.
For example, it’s possible that some federal Judges can still enter into these types of super schemes as can some federal politicians and military personnel.
However, even in those instances, it’s unlikely that the DBGLP entitlements will transfer to a spouse. As part of its investment mandate, the Future Fund is designed (among other things) to pay for these pension liabilities for federal Government employees.
How does defined benefit super work?
Defined benefit super schemes usually work in one of two ways: DBGLP plans and DBGLS plans, as described above.
The key difference lies in how the benefit is paid out – either as a lifetime pension or a lump sum.
Next, DBGLS plans pay out a guaranteed lump sum dollar amount when the member reaches some milestone.
Usually this involves accumulating some set number of points in a scheme which is generally linked to tenure of service in their role i.e. the longer you stay, the more points you’ll accumulate. These plans effectively lock the worker into their job for life.
Now, there’s nothing necessarily wrong with that; it promotes all kinds of stability.
However, a key drawback that I have personally witnessed in practice is that the worker is tied (or scared into staying in) to a job from (say) 20 to 60 and doesn’t have to spend any energy thinking about or learning how to invest or understanding the market-linked super system or investment more generally.
Then, at 60, they’re handed a bag of cash and told that it’s now market-linked and they have to take care of it themselves to fund their retirement—right at the point in time when they need certainty and expertise in managing their nest egg. What could possibly go wrong?
This unbelievable DBGLS situation is at best a massive mistake on the part of those who allowed it to develop this way, and at worst a scam on the worker, locking them into a role with fear of losing their DBGLS—which in most cases, they’d be much better off without anyway.
New DBGLS plans should be banned immediately by law, and careful thought should be given to how best to fairly unwind existing DBGLS plans so as best as possible to not disadvantage the workers who have unfortunately been trapped in them.
As for DBGLP plans, well, these are simply repugnant to the idea of a market-based economy. Be under no mistake; whatever your market is, it should be the ultimate arbiter and allocator of resources in any and all imaginable scenarios, or your economy will end up in serious trouble.
DBGLP plans are highly, highly questionable (and objectionable) now that super caps have been implemented. Specifically, how is it fair for any person’s salary to be guaranteed for life (ever)?
No one should be protected unconditionally from the vicissitudes of the market by a historical employment agreement lest distortions are introduced which effectively result in welfare for the rich.
Commuting all DBGLP plans to market linked pensions is absolutely justified, and even if it fails, the message will have been sent loud and clear.
If we want to have a fair and open economy in Australia, which we should, we need to shine a light on these dark corners of the retirement system which will (unfortunately) live on, at least for a little while longer.
Making this change will ensure Australian taxpayers are never called upon to support the retirement lifestyles of ageing government fat cats from yester-year like retired judges, politicians and figureheads. Cronyism is repugnant to everything good – but don’t take my word for it, ask a Russian.
Should I stay in defined benefit super?
The decision to stay in a defined benefit super scheme is complicated and depends on individual circumstances. However, there are several factors to consider:
- Long-term financial security: While DBGLP plans may seem attractive due to their guaranteed income, they can be inflexible and may not keep pace with inflation or your changing needs in retirement.
- Market exposure: DBGLS plans don’t provide the opportunity to benefit from market growth, potentially limiting your retirement savings.
- Career flexibility: Both types of DB plans can tie you to a single employer, potentially limiting your career opportunities and growth.
- Investment control: Unlike market-linked accumulation accounts, DB plans don’t allow you to make investment decisions, which may not align with your risk tolerance or financial goals.
- Portability: DB plans are often not portable between employers, which can be a significant drawback in today’s dynamic job market.
Given these considerations, it may be worth exploring alternatives such as transitioning to a market-linked accumulation account or even considering an SMSF (Self-Managed Super Fund).
If you’re unsure about your options, it’s advisable to seek professional advice.
View our services to learn how we can assist you with SMSF accounting services.
While defined benefit super schemes may have seemed attractive in the past, they present massive drawbacks for both individual members and the broader economy. As we move towards a more dynamic and equitable financial landscape, it’s necessary to reassess these outdated systems and consider more flexible, market-driven alternatives.
If you’re currently in a defined benefit super scheme and are considering your options, don’t hesitate to reach out to our team of experts. We can help you manage the complexities of superannuation and make sure you’re making the best decisions for your financial future.
For more information on superannuation and retirement planning, you can also visit the Australian Taxation Office (ATO) website.
