Defined benefit pension holders, this one’s for you
Defined Benefit pensions provide a guaranteed pension income stream for those lucky enough to have them. According to the Sydney Morning Defined Benefit pensions provide a guaranteed pension income stream for those lucky enough to have them. According to the Sydney Morning Herald, it’s close to a million Australians1. Offered by a small cohort of corporates and public sector departments, a big advantage of these pensions is that market influences don’t change your income, your employer or the fund takes that risk on for you2. In light of the upcoming super reforms, general advice is, if you do have one, hang on to it but to be sure this is right for you, check with your financial adviser.
Herald, it’s close to a million Australians1. Offered by a small cohort of corporates and public sector departments, a big advantage of these pensions is that market influences don’t change your income, your employer or the fund takes that risk on for you2. In light of the upcoming super reforms, general advice is, if you do have one, hang on to it but to be sure that this is right for you, check with your financial adviser.
As a Defined Benefit pension recipient, you’re probably already aware that the upcoming super reforms treat you a little differently to those who have SMSFs or regular super funds. For one thing, Defined Benefit funds have been deemed too complex to return to a lump sum form and therefore are not subject to the transfer balance cap. Depending on which newspaper or website you’re reading, this considered great by some and unfair by others3. It’s true that many Defined Benefit funds are subject to tax in some form, so the fact that pension income from super is tax free (if your balance is under the new $1.6m Transfer Balance Cap) conveys less benefit to some DB fund holders.
Ultimately each individual Defined Benefit fund has its own conditions and tax requirements, and it’s impossible to generalise. That’s why we keep referring you to your financial adviser to confirm your individual status.
Converting a pension into a lump sum equivalent
The new rules value a Defined Benefit pension by multiplying the annual income it pays by a factor of 16. This factor roughly approximates how many years a newly retired individual is likely to live to receive this income and was calculated by actuaries as being the most fair and appropriate for this calculation. Currently anyone currently over 73/74 would consider a factor of 16 unfair because it’s more than their average expected remaining lifespan. A lower factor for older retirees could be more appropriate for the calculation3.
If at 1 July 2017 you have a defined benefit pension paying $120,000 pa, your pension is valued at $1,920,000
Bonus: if you only have a Defined Benefit pension you CAN’T exceed the TBC
If your Defined Benefit pension is the only superannuation you hold, you’re not required to commute your pension as you would if you held an SMSF or had funds in a public account. Even though, like the example above, the calculated value of your pension is well over the $1.6m Transfer Balance Cap, DB schemes are considered too complex to return to a lump sum form and are therefore exempt. Instead, the super reforms attempt to make things fair by charging extra tax on the income stream you receive. There are also additional concessions for tax you may have already paid on your income as part of the terms of the pension.
If you have a Defined Benefit pension plus an SMSF or other public fund you CAN still exceed the TBC and must act accordingly
If you have a Defined Benefit scheme and a SMSF or public pension fund, it’s a different situation. In the case above, while you could keep your entire $1,920,000 Defined Benefit account intact, any SMSF or non-defined fund you possess would put you over the TBC. You’d need to arrange to commute these funds back into accumulation (subject to 15% tax on earnings) or out of super altogether (subject to the marginal tax rate).
You do have to pay extra tax on the income stream
If you’re a Defined Benefit pension fund holder (to find out if you’re affected, ask your financial adviser) whose balance exceeds the $1.6m TBC, and your annual income from all your pensions is over $100,000, you’re subject to additional income tax laws.
In its simplest form:
For a taxed Defined Benefit pension, where annual income exceeds the $100k cap, 50% of the income is charged at your marginal tax rate.
For an untaxed Defined Benefit pension, where annual income exceeds the $100k cap, the entire amount is charged at full marginal rates but there is a 10% tax offset available from 1 July4. Your financial adviser can explain in more detail how this could affect you.
There is no question, financial advice is a must
Defined Benefit pensions come in many shapes and sizes, they can be taxed or untaxed, they can be subject to market forces or not, you can make additional contributions for some, but not all. Considering the wide range of forms this kind of pension fund can take, individual advice is needed.
Of highest priority is to establish whether you need to commute part of your SMSF or other super from pension phase because your Defined Benefit pension is sucking up your entire Transfer Balance Cap (TBC). As the financial year has less than 6 weeks to run, the window for making these changes is shrinking rapidly. Once this pressing matter is sorted, you may wish to discover if the income from your DB pension could be subject to extra tax.
The best thing to do, and we know we’re being repetitive but it is so important, is to contact your financial adviser and let them help you. When talking about the new super reforms taking effect from July 1st, the area of Defined Benefits is one of the most complex. Any investor needs the guiding hand of someone who knows their stuff.
Modoras’ financial advisers can make sure you’re fully prepared for the upcoming super reforms. If you’re worried about your Defined Benefit pension, the Transfer Balance Cap or anything else we’ve been speaking about over the last few weeks in our super reform series, contact us on 1300 888 803 and speak to one of our experts.
Defined Benefit funds are one of the most complex of areas affected by super reforms. Any affected investor needs financial advice.
Over to you
Do you have a Defined Benefit Fund? Know what you need to do? Already done it?
1. SMH, Daryl Dixon- Dec 2016: Changes to superannuation and how defined benefit members will be affected
2. ATO Moneysmart– Superannuation and retirement, how super works, types of super funds
3. AFR, John Wasiliev–Oct 2016: Retirees with defined benefit pension schemes may need to juggle their assets
4. Superguide¬–Retirement planning: Defined benefit pensions $1.6m transfer balance cap
This article is published by Modoras Pty Ltd ABN 86068034908 AFS and Credit License No. 233209. This article contains general information only and is not intended to represent specific personal advice (Accounting, taxation, financial or credit). No individual personal circumstances have been taken into consideration for the preparation of this material. It is recommended that you obtain your own personal professional advice before making any financial or business decision.