What is a Defined Benefit Pension Worth?

Ah, the defined benefit pension. What I would give to be allowed into one of these schemes.

There is a reason the majority of defined benefit schemes are closed to new members. These schemes come in a variety of forms but they all revolve around receiving a guaranteed pension for life, generally indexed to inflation. Generally, if you pass away before your spouse they will receive 5/8ths of your pension until they also pass away. Once you and your spouse have passed away generally the benefit ceases.  

The other type of superannuation scheme which is far more common today is a defined contribution scheme where you must invest and draw down on your own capital to fund your retirement.  

The majority of private sector defined benefit closed to new members in the 1990s. The state and federal government schemes closed to new members in around 2008 and the Australian Defence Force scheme closed to new members in 2016. As far as I am aware, you can no longer join a defined benefit pension scheme in Australia.  

A great deal of thought should be given to the decision to cash out a defined benefit pension, there is a reason these schemes are closed to new members.  

I have attempted to come up with an approximate value for a defined benefit pension of $50,000.00 per annum.  

To do this I will compare this pension with the closest product you can buy on the private market, a fully inflation protected lifetime annuity, this particular one issued by Challenger.  

In this assumption I will assume that a prospective client is 60 years old and single. The defined benefit pension is actually more valuable to a client with a partner as the partner can continue to receive payments after the death of the client, however for simplicity’s sake we will assume that the client is single.  

To receive a guaranteed, inflation adjusted $50,000.00 for life you would need to give Challenger $1,132,280.00. This is a payout rate of around 4.4%. This is the value I would put on that defined benefit pension for a single 60-year-old man. For a single 60 year old woman the value of this pension is $1,187,930.00 (because women typically live a little longer than men).  

Defined benefit schemes typically give you the option before you commence a pension to cash out your pension as a lump sum, however you won’t receive anywhere near the amount we were talking about above. If you were to cash out your $50,000.00 a year pension received from the Public Sector Superannuation Scheme for a lump sum at retirement you would receive around $575,374.00. This is well short of the $1,132,280.00 or $1,187,930.00 I estimate this pension is worth. 

If you have a defined benefit pension and you are unsure of what you should do at retirement please give us a call on 02 6681 1911 or email client.care@evolutionfinancial.com.au and book a meeting to speak to James or Mitch today.