Inequities loom in DB pensions

In stark contrast to the generous treatment of higher-income contributing defined benefit fund members, the draft legislation contains tough and in some cases unrealistic valuations of the non- commutable defined benefit pensions received by retirees.
 
These valuations determine how much additional private superannuation defined benefit fund retirees can have in separate pension accounts within the new $1.6 million cap.
 
The draft legislation, apparently based on actuarial advice, values all defined benefit pensions by multiplying the annual pension by 16. Using this one figure makes no allowance for differing surviving spouse benefits, the age of the pension recipient or whether the pension is taxable or not. As a result, mainly former federal employees will be disadvantaged compared with state government, Reserve Bank, university and company employees, whose funded defined benefit pensions are tax-free.
 
How professional actuaries could recommend a one-size-fits-all approach defies explanation when defined benefit pensions vary significantly and retired recipients are in different age groups.
 
Applying the 16 multiple to an annual pension of $100,000 puts a $1.6 million valuation on all pensions, even though a $100,000 taxable pensioner receives an annual income of only $83,000.
 
A valuation based on actual income received would in this case value an unfunded taxable pension at $272,000, less than a funded tax-free pension. Apart from this glaring inequity, a fixed 16 valuation factor favours younger defined benefit pension recipients over older.
 
It would be impossible to purchase a CPI-indexed lifetime annuity between 55 and 65 at a valuation factor of 16. But at older ages, such as 75, 80 and 85, the story is completely different. This is why, if the government sticks with its present approach, the valuations of existing defined benefit pensions should err on the generous side.
 
The 16 valuation factor also creates a public relations problem with retired public servants who were members of the PSS and MSBS schemes. These funds allow retiring members to convert lump sum benefits into lifetime indexed pensions using valuation factors of 12 at 55 and 10 at 65.
 
The proposed 16 valuation factor for existing pensions demonstrates the actuarial bargain of the pensions offered by these funds. Nevertheless, explaining why the new super rules values pensions at more than the lump sum available from their fund will be a problem.
 
Even if the government opts to use the 16 valuation factor when defined benefit members commence their pension, the arguments for making adjustments for any tax payable on the pension and for the age of recipient are overwhelming.
 
As one upset reader argued, existing defined benefit pensioners don't have the option of converting their pension to a lump sum if the valuation methodology places too high a value on their pension.

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Daryl Dixon

Executive Chairman

Daryl Dixon is one of Australia’s foremost investment experts and a well known writer and consultant. He has provided trusted advice to thousands of personal clients over more than 25 years and is an acknowledged expert in the areas of tax, superannuation (including public sector superannuation), social security and investments.

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