It has been quite a few years since most corporate defined benefit plans have been closed to new members. As the membership is run down, a point is reached where the cost of operating the arrangement is expensive on a per member basis. In such a situation the company naturally would like to consider closing the plan by converting the remaining members to an accumulation arrangement.
To obtain the consent of the affected members involves designing the transfer value offer and future contribution levels. Often a top up amount is involved and this has the potential to trigger excess contribution tax. The expected tax impact for the member needs to be incorporated in the calculations.
The illustrations for the member need to be on a year by year basis as the resignation benefit in the defined benefit arrangement may not smoothly link to the early retirement benefit design. When considering whether the new arrangement is likely to be better, death and salary continuance benefits need to be factored in, as one must for administration fees. At a practical level the member will want reassurance that the new covers will not be subject to medical requirements. There is potential for the individual to redirect this resource to retirement asset build up if that is their preference.
Benefit projections should be on a number of bases to allow the affected member to judge variability of outcomes. It’s important to point out that these alternatives do not indicate upper or lower bounds of all possible outcomes.
It’s right and proper that the accumulation design should have a greater expected retirement sum. The member has more risk, for example, that at retirement returns may be poor – what is called sequence of return risk. Where I find this risk difference really problematic is when a member is giving up pension rights. Here the member is taking over the payment duration risk (mortality risk), the rate of return that can be achieved (market risk), inflation risk etc.
From an employer sponsor point of view, these exercises are facilitated by the existence of a decent surplus. Interestingly, there is a parallel at the SMSF level. A point may be reached where the cost of SMSF structures do not offset the tax advantages – especially since tax free thresholds and SAPTO may mean little tax on non-super assets. With a shorter planning duration, the interest component in each payment is less.
The NetActuary Team