Should I stay in my defined benefit super fund?
Not many people would pass on a guaranteed lifetime pension. That’s what’s on offer with many defined benefit funds― often referred to as public service superannuation because of their original purpose as a retirement savings vehicle for Australian government employees.
While you may not fully understand the intricacies of the schemes – of which are aplenty - most public servants nowadays would appreciate the value of their defined benefit entitlements. Perhaps now more than ever, these funds are considered even more attractive – not just in the current economic environment where market volatility and low interest rates have dominated returns – but also, with people living longer, having a secure income gives peace of mind and freedom to enjoy retirement.
So, if you’re a current member of a defined benefit super fund and considering retirement, you’ve usually got one chance to make the right decision and planning can pay off. Consider working through the key considerations below to help ensure you avoid possible pitfalls and make the most of your generous super scheme.
The special lump sum value of your annual defined benefit pension
Once you claim your annual defined benefit pension, it will have an associated ‘special lump sum value’. This value is calculated by multiplying your annual gross defined benefit pension by a factor of 16. For example, retired public servant Jane’s annual pension is $60,000, so it will have a defined benefit pension special value of $960,000 ($60,000 multiplied by 16).
The significance of the special lump sum value is that it can limit your ability to make non-concessional contributions, hold money in a tax-free retirement pension and also impact your member contributions.
Here are three things you can do to make effective use of your defined benefit fund:
1. The financial year you retire in may be your last chance to make further super contributions
Your total super balance governs your eligibility to make non-concessional contributions. If you have more than $1.6 million across all your super accounts, you cannot make non-concessional contributions into super.
As your total super balance is assessed at 30 June each year, for those retiring on a defined benefit pension before financial year-end may have a final window of opportunity to top up their super. This is because as soon as the defined benefit pension is claimed, the special value will apply and will count towards your total super balance cap - that may exclude you from making further contributions. Whereas the value of the defined benefit fund account before it is converted to a pension is generally assessed more favourably.
So, if you’re retiring before the financial year end, you should consider the option of bringing forward any planned lump sum contributions before 30 June. This may mean re-assessing the timing around asset sales and leave payouts that are often used after retirement to boost super.
2. Your member contributions may incur penalty tax
Most defined benefit schemes require member contributions to be made to maximise the final entitlement payable on retirement. However, this may become problematic if you have more than $1.6 million in total super and your member contributions are made on an after-tax basis. In this scenario, your member contributions would be considered excess contributions and will incur a tax penalty.
However, because member contributions help maximise your final payout, the long-term benefits outweigh the tax penalties incurred, so it’s important to consider the overall impact of your member contributions, before stopping or reducing these.
3. Planning how to structure other super accounts
If you’ve built up another retirement nest egg – perhaps through a salary sacrifice arrangement into a private super account, it can be worthwhile planning out how best to structure this type of super in retirement
For retirement pensions, a separate $1.6 million limit applies – the rule is, you can hold a maximum of $1.6 million in the tax-free phase of super – this includes any defined benefit special lump sum value.
If your defined benefit special value doesn’t fully use up this cap, what does this mean for your private super account? You could commence a tax-free retirement pension from part, or all, of it – depending on your balance – and essentially squeeze more into the tax-free retirement phase. For example, Jane’s $960,000 defined benefit pension special value means if she had a private super account, she could have up to $640,000 of it in a tax-free retirement pension. If Jane’s private super account had a balance greater than this, the excess amount would have to be kept in accumulation phase but importantly, doesn’t have to be withdrawn out of super altogether.
Want to learn more about your defined benefit super fund?
Whether you’re about to retire or not, if you’re a member of a defined benefit super scheme, such as the Public Sector Superannuation Scheme (PSS), Commonwealth Superannuation Scheme (CSS), Military Superannuation and Benefits Scheme (MSBS) and Defence Force Retirement and Benefits Scheme (DFRDB) – to name just a few - and want to better understand your options and how to maximise your benefits, come and talk to one of our specialist financial advisers.
This insight may contain general financial advice and was prepared without taking into account your objectives, financial situation or needs. Before acting on any advice, you should consider whether the advice is appropriate to you. Seeking professional personal advice is always highly recommended. Any forward-looking statements are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct.