What is a defined benefit Pension?
A Defined benefit fund is an employer-sponsored superannuation fund that generally calculates the benefits an employee would receive on retirement, or on another event, such as resignation, using a predetermined formula. Members of defined benefit funds usually do not have individual accounts as is the case with accumulation funds. Generally funds are pooled in the superannuation plan and are invested according to an overall fund strategy. The employer contributes amounts to the fund as required (determined by an actuary), to ensure there is sufficient money in the pool to make benefit payments to members as they fall due.
With defined benefit funds, it is the employer that takes on the investment risk, as the employer guarantees the end payment. If there are not enough returns generated by the fund to provide for member benefit payment as they fall due, the employer must make further contributions to make up the difference. For this reason, there are becoming fewer defined benefit pensions as employers are not willing to take on the risk of managing investments and tracking inflation.
The benefits payable at retirement are generally calculated using a formula based on length of service of membership in the fund and average salary over the last few years before retirement.
Note: Defined benefit pensions can no longer be paid from SMSF’s however, existing defined benefit pensions that commenced prior to 31st December 2005 can continue to be paid.
Who is entitled?
As a defined benefit fund is an employer-sponsored retirement pension, not everyone is able to apply for this type of pension fund. Defined benefit pensions are usually only available to employees that have employers who have set up a defined benefit fund or to permanent employees in higher education or within the research sector. To be entitled to receive your pension you may have to work a specific number of years before you have the right to a defined benefit pension. If you leave your job before you satisfy the number of years under your employer’s defined benefit plan, you will not be entitled to full retirement benefits from the Defined Benefit Fund.
How much income is received?
A recipient is entitled to their pension from their Defined Benefit Fund once they reach 65 or retirement. The formula to understand how much income you will receive is calculated by averaging the employee’s earnings either over their career or towards their last few years of employment, taking a specified percentage of the average and multiplying it by their years of service.
The example below illustrates the benefits that would be payable on commencing a Defined Benefit Pension.
Example: An employee works for 20 years and has an average salary of $100,000 at retirement. The accrued percentage average of super contributions is 20%. What income are they entitled to receive from their Defined Benefit Pension?
The formula would be 20 years x $100,000 x 20% = $400,000.
There are a number of ways of how you can receive your benefits. You have the option of taking your pension as a lump sum payment, or as a single life annuity; where a fixed monthly benefit will be paid to you until you die, or as a qualified joint and survivor annuity; where you will be able to receive a fixed monthly benefit until you die. After your death, your surviving spouse can continue to receive payments, at either an amount equivalent to at least 50% of your benefit until they pass away.
How to start receive benefits from your Defined Benefit Fund and who can set it up?
You can start to receive benefits from your Defined benefit fund at age 65 or when you commence retirement. This when your employer will stop contributing to your pension. If you plan to retire within the next 12 months, you should discuss this with your employer so that an estimate of your pension benefit can be calculated. To help you understand the amount you will need as a pension and structure your retirement to continue a comfortable lifestyle, it is best to contact a financial adviser as they will be able to assist you and tailor a retirement plan specific to your needs.
Where can I get more information?
You can read more about Defined Benefit Pensions here: http://www.actuaries.asn.au/Library/Events/FSF/2012/FSF2012PaperEinfeld.pdf
IMPORTANT – The information on this website is general in nature and does not take into account your personal needs and objectives, you should not act upon any of this information without first seeking advice from a qualified professional.