Vested interests can push defined benefit members to take a lump sum

It comes as no surprise that several readers of last week's article on the attractions of defined benefit indexed pensions commented that their super fund administrator or adviser had recommended taking at least part of their benefit as a lump sum.

Given the generosity of most defined-benefit pension funds, there are substantial benefits for employers when members cash out their entitlements.

For advisers also, there are financial benefits, including ongoing fees and charges available from managing lump sum benefits.

The decision whether to take a defined benefit as a pension is one of the most important decisions a retiree must take. Once the decision to take a defined-benefit pension is made, there are no further ongoing fees and charges with the pension being paid regularly into the nominated bank account.

Compared with the conditions in the 1980s and 1990s when interest rates reached as high as 18 per cent a year, decisions today are made in the context of historically low interest rates and volatile investment returns since the global financial crisis. The severely tightened age pension assets test introduced this year has also impacted adversely on many recipients of lump sum super benefits by reducing age pension entitlements by 7.8 per cent of assets above the free area.

While taking a lump sum component of a defined-benefit payout might still be a sound decision, there's no substitute for making a detailed comparison of the alternative defined-benefit options. The greatest uncertainty in opting to take a non-commutable lifetime pension is of the expected life span of the pension recipient. If there's a partner eligible for a surviving spouse pension, the attractions of the lifetime pension are increased.

The problem for lump sum investors is to ensure that their money doesn't run out while they are alive, forcing them to rely totally on the age pension.

Even when the employer-funded defined benefit pension is taxable as it is in part or totally for federal defined benefit funds, the tax payable has, over the years, been reduced by the trebling of the tax threshold and the introduction of a 10 per cent rebate on taxable income up to $100,000 annually.

There's a further benefit for pension recipients with modest or even medium annual incomes. Non-commutable defined benefit pensions aren't counted as assets for purposes of the assets test and eligibility for an age pension is assessed under the more generous income test.

While the asset test changes have reduced or completely removed the part-pension entitlement of about 300,000 retirees, those assessed under the income test including defined benefit pensioners haven't been affected. Clearly, the potential impact on future age entitlements is another important factor when evaluating the worth of defined benefit non-commutable pensions.

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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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