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There’s lots of jargon in the super system and even when it comes to something as simple as the different types of super funds, it can be hard to know what they are and how they work.
One of the key differences you need to understand when comparing two super funds is whether the fund is a defined benefit or an accumulation super fund.
Accumulation or defined benefit: What’s the difference?
These days, most Australians are members of an accumulation super fund but it was a different story in the days before super became a workplace entitlement for all employees.
Back then – if you had a super account at all – it was much more likely to be in a defined benefit super fund. As the Productivity Commission’s 2018 report noted, super “began in 1862 with the establishment of a defined benefit pension fund for the employees of the Bank of NSW. Superannuation followed this model for the next 100 years: defined benefit pension funds were established for a minority of employees, who were generally higher-paid white-collar employees in the private sector or civil servants in the public sector.”
So defined benefit super funds are the traditional form of super fund and accumulation funds are their younger siblings.
But being an older type of super fund doesn’t mean a defined benefit fund is out-dated, in fact, in many ways they offer their members a much better deal than the newer style accumulation funds.
Who gets to be in a defined benefit fund?
Accumulation super funds are now far more common than defined benefit super funds, with most of the industry and retail super funds offered to employees when they join a new company being this type of super fund.
Defined benefit funds on the other hand, are mostly for public sector (government) and corporate employees. Many defined benefit funds are now closed to new members.
Some of the large corporate defined benefit super funds include TelstraSuper, Qantas Super and Rio Tinto Staff Super Fund, while government defined benefit funds include the Commonwealth Superannuation Scheme Fund (CSS), UniSuper and the WA-based Gold State Super.
Be very careful before taking your super benefits out of a defined benefit super fund.
Many of these super funds have been around a long time and the benefits members receive are often very generous – usually much more so than what members of other super funds receive.
The key advantage is that you are guaranteed to received a specific (or defined) benefit when you retire, irrespective of what’s happening in the investment markets or how the super fund is performing.
Calculating your withdrawal benefit: Accumulation vs. defined benefit
Accumulation (or defined contribution) super funds
In an accumulation super fund, it’s all about how much you accumulate in your super account over time from super contributions and investment earnings, minus fees, taxes and charges.
How accumulation funds calculate your retirement benefit
Employer contributions + personal contributions + investment earnings – fees and taxes = final super benefit on withdrawal
As a fund member in an accumulation super fund, you take the risk that when you retire the balance of your super account declines if there is a slump in the investment markets.
Defined benefit (DB) super funds
In a defined benefit fund, your super benefit when you retire is not solely dependant on super contributions and investment earnings.
Your employer is required to contribute regularly towards your defined benefit. These employer contributions are not allocated to individual member accounts, however, instead they are allocated to a defined benefit pool, from which all of the fund’s defined benefits are paid to members.
What you receive when you retire (or leave your employer) and withdraw your super benefit is based on a formula in the rules (trust deed) of the super fund and these vary between individual defined benefit funds.
If you are a member of a defined benefit super fund, the amount you receive will depend on factors like how much your employer has contributed into your account, how much you have contributed, how long you have worked for your employer and your final salary when you retire.
How a defined benefit fund calculates your retirement benefit
(Note: The formula used is different for each DB fund.)
Years of service x final average salary OR set factor = final super benefit on withdrawal
Example: After 30 years service with your employer, your retirement benefit might be (depending on the rules of the individual super fund):
6 x your final salary (as a lump sum)
80% of your final salary (as a monthly pension) until your death.
As a fund member in a defined benefit super fund, your employer or the super fund takes the investment risk if you retire when markets are down.
If this is the case, your employer or the super fund is responsible for topping up the amount you receive so your retirement benefit is the amount specified by the super fund’s rules. Because the employer has to carry this risk, many defined benefit super funds are now closed to new members.
There are three main types of defined benefit fund and different rules apply when calculating their super contribution amounts. The rules depend on whether contributions are made to:
- a funded defined benefit fund (often corporate super funds)
- an unfunded defined benefit fund (often older public sector funds, including Constitutionally protected super funds)
- a hybrid super fund (provides a defined benefit and also allows members to have an accumulation account)
Contact your super fund to find out if it is a funded or unfunded defined benefit fund, or a hybrid super fund.
Pros and cons of defined benefit funds
Employer/super fund is responsible for providing fixed future benefit to employee
Future super benefits do not belong to the member and are not always fully transportable
Eliminates worry about the performance of investment markets
Tax rules may differ on withdrawal (see section below)
Guaranteed payout amount based on a clear formula
No say in how the fund’s assets are invested
Payout amount is not affected by performance of investment markets
Benefit may not be adjusted for inflation
Takes the guesswork out of knowing how much you will have at retirement
Fund rules could be modified, leaving members with a different level of benefits at retirement
No need to select an investment option
May be possible to achieve bigger benefit with an accumulation fund, depending on the investment option selected
Allows you to work out how long you will need to continue working to retire with a set amount
In some older DB funds, benefit does not vest* if you leave the employer before a certain age
* Vesting is the inclusion of all or part of your employer’s contributions in the benefit payment you receive if you terminate your employment before being eligible for a retirement benefit (e.g. before age 55). If the super fund rules require partial vesting, only some of the employer’s contributions are added to your benefit if you leave. Generally, this only occurs in older government super funds for long-term public servants.
Defined benefit fund members: Know the rules
If you decided to take your benefits out of a defined benefit super fund, or want to consolidate them with another super fund account (including an SMSF), check the rules of your super fund carefully, as you may lose valuable benefits such as generous, low-cost insurance cover and extra contributions from your employer.
It’s also important to remember that if you are a member of a defined benefit fund, in some circumstances your tax rate may be different when you reach age 60 and withdraw your benefits. Generally, when you are aged 60 or over and decide to take a super pension, all your pension payments are tax-free.
If you are a member of a small number of defined benefit super funds, or you receive a defined benefit pension over a certain annual limit ($100,000 in 2018/2019), however, you may be required to pay tax on part of your super pension.
For more information, see SuperGuide article Over age 60? A simple tax guide to accessing your super benefits
Always seek independent professional help from an adviser who is familiar with the rules and advantages offered by defined benefit super funds. (Most defined benefit funds have advisers available who have a detailed knowledge of the fund’s rules.)
Many accountants and financial advisers are unfamiliar with the way defined benefit funds work and the significant advantages they offer their members, so ensure you speak to someone who really understands how these funds work.
Exiting a defined benefit fund is usually a one-way trip, as most funds are unwilling to allow you to re-join the fund if you leave, so ensure you understand the risks and benefits before you make any decision.