Defined benefit funds v super: What you need to know


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Defined benefit funds are often seen as the holy grail of super, but they do have downsides.

Picture this. A prospective employer explains that if you stay with the organisation until age 60, you'll have a guaranteed super-based income in retirement.

It may sound too good to be true. But that's exactly what can be up for grabs if you join a 'defined benefit' super fund.

defined benefit super fund v super fund

With this type of fund, your final super payout is determined by a set formula. It varies between funds, but it chiefly hinges on your years of service and final salary prior to retirement.

It's a very different prospect from an 'accumulation' fund, where your final payout depends on how much you or your employer(s) contribute, less fees - and critically, how much your super earns in investment returns.

Near-zero risk for workers

The vast majority of Australians have their super in an accumulation fund. But 876,000 workers are with a defined benefit fund. Nonetheless, these funds are fast heading the way of the Tasmanian tiger - and with good reason.

The payout formula of a defined benefit fund provides certainty around how much money you'll retire on. That's a significant advantage over an accumulation fund where the value of your super can drop substantially if investment markets fall.

We saw this happen in early 2020 when the Aussie sharemarket plunged 30% at the start of the pandemic. According to estimates from SuperRatings, 'balanced' super funds dipped 10% in the March 2020 quarter. 'Growth' investment options with greater exposure to shares, were down 14.1% over the quarter.

That's a big chunk of retirement savings to lose if you're about to head into retirement.

In a defined benefit fund, it doesn't matter how your fund's underlying investments perform. Your end benefit is paid anyway. This shifts the element of risk away from you, and onto your employer - often a government body.

A decline in defined benefit funds

The transfer of risk from worker to employer goes a long way to explaining why defined benefit funds are becoming a thing of the past. They were common in public sector and local government workplaces until the 1990s. These days, they are limited to a small selection of employers - often public service organisations such as emergency services or large public companies like Telstra.

Many of the defined benefit funds still in place are closed to new members meaning longer-serving employees tend to form the bulk of members.

The downsides of defined benefit funds

A super fund that guarantees a set payout in retirement can seem like an unbeatable proposition, however there are drawbacks.

Defined benefit funds work in a variety of ways. Some ask employers to make contributions above the Superannuation Guarantee benchmark of 10%. This can mean lower wage growth for employees. In addition, fund members may be asked to make contributions of their own, which are added to the pool of money that provides benefits to all members of the fund.

A key downside is the so-called 'golden handcuffs' situation. This is where people can be reluctant to leave a job - even one they dislike, because the end super benefit is so attractive.

For employees who do move to a new employer, switching from a defined benefit fund to an accumulation fund can be a complicated exercise.

Industry body ASFA says some defined benefit funds don't allow you to move your super at all when you change jobs. Among those that do, complex rules can apply.

Reading the fund rules is important in these circumstances. It can also be worth investing in professional financial advice to know how the decision to farewell a job with defined benefit super can impact your final nest egg. This complexity can make an accumulation fund look like a far simpler - and more flexible - option.

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A former Chartered Accountant, Nicola Field has been a regular contributor to Money for 20 years, and writes on personal finance issues for some of Australia's largest financial institutions. She is the author of Investing in Your Child's Future and Baby or Bust, and has collaborated with Paul Clitheroe on a variety of projects including radio scripts, newspaper columns, and several books.