Before superannuation was made compulsory in 1992 the most popular type of superannuation fund was the final salary Defined Benefit Fund.However membership of these funds was generally restricted to salaried employees and was part of their Contract of Employment.
When superannuation was made compulsory in 1992 many Trustees established a money purchase Defined Contribution Fund into which the Employer was required to make contributions under the Superannuation Guarantee for their wages Employees.
Since the Employer bares the investment risk in a final salary Defined Benefit Fund, whilst the Employee bares the investment risk in a money purchase Defined Contribution Fund, many Employers decided to close the final salary Defined Benefit Funds to new salaried Employees.
Many Employers then instructed the Trustees to made an offer to existing members of the final salary Defined Benefit Fund to voluntarily leave this Fund and to join the new money purchase Defined Contribution Fund.
Many of these offers were made in the 1990s when there had been a two decade long “Bull Market” in global share markets. Therefore it was easy to present optimistic projections as to the investment returns members might expect if they agreed to switch to the new money purchase Defined Contribution Fund, without properly advising these Members of the investment risk they faced.
Furthermore the amount of death and disability cover provided in the new fund was often substantially less than in the older fund. This was often not mentioned.
Members who were misled into agreeing to leave their final salary Defined Benefit Fund in the 1990s would now be regretting the decision since there has been a sustained “Bear Market” in global financial markets since 2000 which is likely to continue for another decade.
The average return of money purchase Defined Contribution Funds over the last decade has been around 3.5% per annum barely keeping pace with inflation.
Most actuaries assume a long term rate of return of 8% for superannuation fund investments and this figure would have been used to encourage Members to switch to the new money purchase Defined Contribution Funds.
Bill Black and Wendy White are Members of a final salary Defined Benefit Fund with 20 years Fund Membership and both plan to retire in 10 years. Both have an annual salary of $100,000 per annum. The accrual rate of the Member’s Benefit Multiple is 18% per annum
The Trustee at the Employer’s request makes an offer to all Members to voluntarily leave the final salary Defined Benefit Fund and join the new money purchase Defined Contribution Fund with their Defined Benefit “cashed out” and rolled over into the new Fund.
A presentation is made to Members based on the expected actuarial rate of return of 8% per annum for the new money purchase Defined Contribution Fund. The Employer agrees to make the 9% statutory contribution into each Member’s superannuation investment account.
Bill Black agrees to this offer however Wendy White declines.
Assuming Both Bill and Wendy’s salaries increase in line with the average growth rate in average weekly earnings of 4.5% per annum and neither gets a further promotion, then both will have a salary in 10 years time of $155,000.
After 30 years of Fund Membership Wendy will have a Member’s Benefit Multiple of 5.4 giving her a Defined Benefit of $803,000 (assuming final average salary is the average of the last 3 years of service).
If the Employer contributes at a rate of the statutory 9% for the next 10 years and the money purchase Defined Contribution Fund does achieve the actuarial rate of return of 8% per annum then Bill Black will receive slightly more than Wendy White at $828,600.
This would be the projection presented to members to encourage them to switch funds.
But what happens if the actual return after expenses is only 3.5% as the average has been over the last decade? Bill Black’s money purchase Defined Contribution Benefit falls to $607,800. Bill’s decision to change funds has now cost him nearly $200,000 or 25% of his benefit had be decided to remain a member of the final salary Defined Benefit Fund.
In Scenario A neither Bill or Wendy receives a promotion in their final 10 years of service. What happens if both receive a promotion 5 years before they retire. A promotion that increase their salary by $25,000 per annum above the normal 4.5% increase
The final salary of both Bill and Wendy increases from $155,000 per annum to $186,500 per annum giving Wendy a final salary Defined Benefit of $964,000 a substantial increase from $803,000 without a promotion.
However Bill’s money purchase Defined Contribution only increases from $828,600 to $845,600 if the Fund achieves the actuarial return rate of 8% so Bill is now $118,000 worse off than Wendy.
But what happens to Bill if his Fund only achieves the 3.5% rate of return?
Bill’s money purchase Defined Contribution increases from $607,800 to $623,800, however Bill is now $340,000 worse off than Wendy who decided to remain in the final salary Defined Benefit Fund. Bill lost 35% of his potential benefit by accepting the offer to switch funds.
The question now is: “Was Bill properly informed before he made a decision to accept the offer to transfer from the final salary Defined Benefit Fund to the new money purchase Defined Contribution Fund?”
Was Bill properly informed about:
- Investment Risk? and
- Promotional Risk?
A final salary Defined Benefit Fund is much more advantageous if the Member receives a promotion in the 5 to 10 years before they leave the Fund compared to a money purchase Defined Contribution Fund, even if the Defined Contribution Fund can achieve the actuarial rate of return of 8% per annum. How many members were advised of this before they accepted the offer to switch funds?
If you accepted an offer to leave a final salary Defined Benefit fund and transfer to money purchase Defined Contribution fund, then Australian Guardians would like to hear from you.
Your legal right to obtain a benefit from a final salary Defined Benefit Fund is a right that you should not have repudiated unless you were properly informed of the risks you faced if you accepted an offer to join a money purchase Defined Contribution Fund.
Australian Guardians is seeking legal advise as to whether a Tort of Deceit might lie against Trustees who failed to properly inform Members about the risks they would face if they accepted the offer to change Funds put to them by the Trustee at the Employers request.
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