Thursday, April 16, 2009

Defined Benefit vs. Defined Contribution

The major decision I need to make in response to receiving my job contract is which type of superannuation (retirement) scheme to join. Yes, we have a choice between defined benefit and defined contribution (or accumulation in the Australian jargon). Defined benefit is mainly based on your average salary in the last three years that you work for a university that is a member of the Unisuper fund (indexed for inflation) and the number of years that you contribute to the fund. So here the main risk is career risk. This option performs best for someone who will work their whole career at Australian Universities and get promoted to professor or dean right at the end of their career. In defined contribution you have both a career and a market risk but much more of a market risk. An important benefit of the defined contribution is that you can rollover your benefit into another superannuation fund - i.e. it is portable - while the defined benefit is not.

When I previously worked at an Australian university we initially had no choice and were all in a defined benefit scheme. Then when we were given the choice of switching to defined contribution I did it immediately as I didn't expect to stay in the Australian university system in the long-term. After I left the university I rolled my super into Colonial First State. That was all going well until some unfortunate investment decisions last year.

Given my great career uncertainty at this point it seems obvious to go for the defined contribution scheme. But I will do a proper analysis and report back with the results.

The Unisuper scheme has, on top of a massive 17% employer contribution, a required 7% contribution from the employee's nominal salary. To balance things out, and given our higher income now, I will start 7% "salary sacrificing" (pre-tax employee contribution) for Snork Maiden too. Her employer contributes 15.4%. As her salary is higher, it seems fair to me to go for the equal percentage salary sacrifices.

BTW I'll see no gain from salary sacrificing this tax year as my marginal tax rate is 15% which is the same as the superannuation contributions tax.*

* In Australia retirement contributions are usually taxed at 15% going into the fund. You can choose to make employee contributions pre- or post-tax. Post-tax ones don't attract the contributions tax but obviously you pay your regular income tax on them. If your marginal tax rate is above 15% (as most people's is) then it seems like a no-brainer to go for the pre-tax contribution known as "salary sacrifice".

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