UniSuper's DBD vs. Accumulation 2

What is UniSuper's Defined Benefit Division?

The Defined Benefit Division (DBD) is the default option for many Australian researchers at rank of lecturer and above to save for retirement.

Benefit formula

In contrast to historical Defined Benefit Divisions, UniSuper's DBD does not automatically guarantee a monthly pension, but rather has a formula to determine the account value ("the defined benefit") for its members. The formula is explained here and is given by:

Defined Benefit = Benefit Salary x Benefit Service x Lump Sum Factor x Average Service Fraction x Average Contribution Factor

The five components are as follows:

• Benefit Salary. This is the average salary for the last five years when contributing to the DBD. In case of time-off, illnesses or similar, the amount is interpolated as described in here.

• Benefit Service. This is the length of time you have been a DBD member in years (plus a potential fraction of a year for additional days).

• Lump Sum Factor. This factor depends on your age when you retire/leave is listed in the table here on page 52 and ranges from 18% (for retirement/leaving at age 40 or below) up to 23% (for retirement/leaving at age 65 or above).

• Average Service Fraction. This Fraction represents your average (time-weighted) full-time employment. If you have always been employed full-time, your average service fraction will be 100%.

• Average Contribution Factor. Depending on what percentage of your salary, you contribute yourself (between 0% to 7% after-tax or 0% to 8.25% after-tax), your contribution factor (at the given time) is somewhere between 74.5% and 100% as listed in the respective table on page 51 here. Note that lowering your contributions also affects your insurance cover, so even if your retirement benefit is not affected, you may still contribute the maximal amount.

Comparison: DBD vs. Accumulation 2

The following bullet lists should give a general idea of the most important differences between the Defined Benefit Division and Accumulation 2.

Model calculation for six examples

Assumptions for our calculation

• Ignoring inflation. We assume that apart from promotions salaries increase according to inflation. As we will ignore inflation also for the calculation of historical returns (i.e., take "real returns" rather than "nominal returns"), we can perform our calculation with a single salary table for the respective positions/promotions. We will use the salary table for the University of Melbourne from 2021. Consequently, we assume that the person of our calculation example is always paid according to this single salary table. If academic salaries increase faster than inflation, the DBD will benefit from this additional growth, while Accumulation 2 will benefit in the comparison if wages stagnate. We do not have a model for this, but based on past history wage growth appears to be just slightly above inflation. For example, from 2010 to 2020 the base amount of the Australian Future Fellowship covered by ARC increased from 98,935 AUD to 123,620.42 AUD (annualized increase of 2.25% p.a.), while the Australian Consumer Price Index rose from 95.2 to 116.6 (annualized increase of 2.05% p.a.).

• Current tax law in effect. Tax rules are important when calculating superannuation benefits, but they also tend to change over time. However, in order to perform a definite calculation we cannot predict future changes of tax laws. Consequently, we will perform all calculations based on the current tax laws in effect, as of June 2021.

• Yearly payments and returns. As our analysis focuses on periods of many years, we ignore the error that we are making by considering everything in yearly steps. We thus assume that the full super contributions of a given year is deposited at the beginning of the year and the resulting total is withdrawn at the end. Technically, we thereby overestimate the total value of our stock portfolio slightly (maximally by a few percent), but as our calculation only gives rough estimates anyway, this suffices.

• Fixed contributions. We assume that the university contributes 14% of the researchers salary into the DBD, while the researcher contributes 8.24% pre-tax (leading to 7% contributions after 15% tax is applied). This typically corresponds to the most tax-efficient DBD contributions, where the university contributes 14% into the DBD and 3% into the accumulation component. We will ignore the accumulation component, as its return will behave just like an Accumulation 2 investment with a return based on underlying investment choices.

• Taxation of DBD contributions. For DBD contributions, taxation is largely already built into the DBD formula and the only tax effect is that employee contributions are made pre-tax and so the employee needs to contribute 8.24%, so that 7% remain after the relevant DBD tax is applied. In this context, it is important to note that the concessional contributions cap only applies indirectly to DBD contributions via the so-called notional taxed contributions (NTC), which are typically much lower than the actual DBD contributions. Therefore, generally a smaller amount (if any) will exceed the concessional contributions limit, which will be taxed at the marginal tax rate.

• Taxation of Accumulation 2 contributions. For Accumulation 2 contributions, the amount below the concessional contributions cap will be taxed at 15%, while the amount above will be taxed at the marginal tax rate. The marginal tax rate is 45% plus medicare levy and potentially the medicare levy surcharge. We will generally (and rather generously) assume a total marginal tax rate of 50%, which typically leads to a small advantage of DBD members in this comparison.

• Effective calculation of the relative impact of taxes. When we compare the taxation of DBD vs. Accumulation 2, we also need to take into account that somebody in DBD will generally have a lower amount counting towards their concessional contributions, which implies that a larger additional amount will be taxed at only 15%, so that the difference could be contributed in the DBD's accumulation component. As we expect that the accumulation component will generally grow just as an accumulation 2 account, we can equivalently subtract the relative tax advantage by assuming a generous marginal tax rate of 50%, so that the relative tax advantage (with respect to the reduced rate of 15%) is equal 35%. We therefore first apply 85% to the total pre-tax Accumulation 2 contributions (to get the after-tax contributions) and subtract then the tax advantage of 35% of the difference (between pre-tax Accumulation 2 contribution and notional tax contribution).
  Example 1: The DBD member has a notional taxable contributions (NTC) of 15,000 AUD, while the Accumulation 2 member with the same pre-tax contributions has actually 17,000 AUD in contributions (counting against the concessional contributions limit). Rather than modelling that the DBD member could contribute 2,000 AUD more to the Accumulation component taxed at a lower tax rate, we subtract a relative tax advantage of 35% of the difference (here: 2,000 AUD) from the money invested by the Accumulation 2 member to find the Equivalent super after-tax contribution, namely 85% * 17,000 AUD - 35% * 2,000 AUD = 13,750 AUD.
  Example 2: The DBD member has a notional taxable contributions (NTC) of 29,000 AUD, while the Accumulation 2 member with the same pre-tax contributions has actually 35,000 AUD in contributions (counting against the concessional contributions limit). Again, we subtract 35% of the difference of 6,000 AUD, so we find the Equivalent super after-tax contribution of 85% * 35,000 AUD - 35% * 6,000 AUD = 27,650 AUD. We can ignore the additional tax on the 4,000 AUD that also the DBD member exceeds the Concessional Contributions Cap, as this tax must be paid by both members (and thus can be ignored in the comparison).

• Ignoring accumulation component. As we compare DBD with Accumulation 2, we do not consider the Accumulation component of DBD members, which will generally behave just as Accumulation 2. Consequently, we also do not take the 3% employer contribution towards the Accumulation component into account when we compute the equivalent amount that we invest via Accumulation 2 instead.

• Taking the built-in insurance cover into account. In contrast to Accumulation 2, DBD comes with built-in insurance cover, which can only be approximately replicated by buying additional insurance cover though UniSuper or other insurance companies. As insurance rates are changing and also depend on personal circumstances, we only approximated the actual annual value of the built-in insurance cover. For this, we subtracted 1.5% of the annual salary (before tax) from the total contributions available for investments. This estimate is compatible with UniSuper's own estimates, which show that somebody with a salary of 100,000 AUD swapping from DBD to Accumulation 2 will spend roughly 1,400 AUD per year (25 AUD per week) for equivalent/similar cover.

• Historical returns. As we are comparing real returns (after cost, inflation and taxes), we compare with the conservative estimates of 4%, 5% and 6% p.a. on the stock market returns over the respective periods of time. We do not perform Monte-Carlo simulations to show realistic fluctuations, but only quote the respective capital growth for a fixed annual return. The given values are realistic based on past performance of common stock indices. According to the following tables (derived from this source), 90% of all 30-year periods between 1871 and 2021 had historical real return of the S&P500 (after cost, inflation and taxes with dividend reinvestment) above 4% p.a., 80% of the periods above 5% p.a. and 60% of the periods even above 6% p.a., so that our comparison appears realistic.

Six representative examples

We prepared the following list of examples, for which we compare DBD with Accumulation 2 (assuming a return of 4-6% p.a.).

• Example 1: Young hire with steady promotions. Lecturer at 31, Senior Lecturer at 37, Associate Professor at 43, Professor at 47.

• Example 2: Older hire with steady promotions. Lecturer at 41, Senior Lecturer at 47, Associate Professor at 53, Professor at 57.

• Example 3: Young higher with rapid promotions. Lecturer at 31, Senior Lecturer at 34, Associate Professor at 37, Professor at 40.

• Example 4: Older hire on experienced level. Associate professor at 55, professor at 59. This case applies to international hires, where an already established researcher may be hired from another country to directly start on higher level.

• Example 5: Young higher with slow stagnating promotions. Lecturer at 31, Senior Lecturer at 37, Associate Professor at 47.

• Example 6: Older hire with late promotions. Lecturer at 45, Senior Lecturer at 58, Associate Professor at 60, Professor at 62.

For each of these examples, we model the yearly contributions (based on the respective salary scales) and compare the value of your Defined Benefit with an Accumulation 2 investment at a given average return of 4-6% p.a. on your contributions. We also calculate how much you will have contributed in total (at zero return). The following table lists these numbers for the above examples and a retirement age of 65 and 70. Moreover, you can access the in-depth calculation for each example (using the respective tab), where we calculate all these values for each year since hire.

How to build your own model

Above spreadsheet is freely available by just making a copy for your own use. You can then modify the respective entries of a given example to match your personal situation. In most situation, it should be sufficient to edit the first two blue columns (age and rank), but you can fine-tune even specific contribution levels and if you want to contribute before-tax or after-tax. You can even import your own salary tables (using the tab "Pay grades 2021") or directly provide the respective salary for a given year.

Summary of results

We generally find that for most people Accumulation 2 is the better choice provided that one can expect a real return of 4-6% p. a. (i.e., after inflation). Based on past history, this realistically achievable with a diversified low-cost portfolio covering the international stock markets of the world. The longer the investment period, the more likely it is that these historical averages are actually achieved.

On the one hand, researchers who are hired at a young age and are quickly promoted (such as example 1 and 3) benefit from early and high contributions that have sufficient time to grow in a diversified portfolio. The same applies to researchers who are hired early, but then do not progress as much in terms of promotions (such as example 5). In all of these cases, the fact that the DBD is largely based on the average salary of the last five years is not as beneficial.

On the other hand, later hires (such as examples 3-6) see a clear advantage for DBD, which is even more visible for early retirements. This is particularly true for researchers who are directly hired on a high level (such as example 4) or who get their final promotions relatively late in their career (such as example 6).

While in most of the latter cases, Accumulation 2 with a fixed return of 4-6% may still be competitive, let us emphasize that in these cases the market risk is significantly higher, as there is less time to wait out market downturns. Therefore, DBD will likely be better the choice, unless the respective researcher already has significant savings or retirement benefits (e.g., from another country or earlier superannuation contributions).

List of suggestions

The following suggestions are based on the above simulation, but also cover related tax advantages and general portfolio returns (based on past returns). None of these suggestions constitute professional financial or tax advice, so it is imperative that you both verify the contained information (to ensure that they are still correct and apply to your circumstances).

• Make a free appointment with UniSuper advisor. While above spreadsheet model may be helpful to get an understanding of how the DBD membership works, UniSuper also offers the option to meet with an advisor for free. These meetings generally have a good reputation and it is a good idea to take advantage of them.

• Make your decision after careful considerations in time. It is very interesting that the return of DBD appears to be highest in the first two years. This is due to the fact that we reduce the Accumulation 2 contributions by the relative DBD tax advantage and the cost of the insurance (otherwise, the DBD return would be often negative). This is very interesting and could potentially indicate that it is advantageous to wait exactly two years before swapping to DBD. We would generally advise against this, as retirement savings should not be about gaming the system and it is more important to make a well-founded decision. If you intend to switch to Accumulation 2, you should make sure that you do not miss the two year deadline.

• Calculate early if you should salary-sacrifice or make after-tax contributions. For your own contributions, you have the choice to either salary-sacrifice your contributions (leading to a low tax of only 15%) or pay them from your after-tax income (leading to a full taxation at your marginal tax rate). As long as you are below your concessional contribution cap, it is likely a good idea to make pre-tax payments based on salary sacrifice. You should make this decision soon after you are hired, because of the following limitations:
  Defined Benefit Division: You cannot reclassify your contributions retrospectively, but only change between pre-tax and after-tax for future contributions, so it is imperative that you make a conscious choice (often pre-tax contributions are advantageous).
  Accumulation 2: You can retrospectively convert after-tax contributions into pre-tax contributions by notifying UniSuper that you intend to claim your contributions in your tax return. However, you cannot reclassify pre-tax contributions to after-tax contributions (except where you can effectively withdraw some contributions due to exceeding the concessional contributions cap).

• Accumulation 2 is excellent for young hires and those who expect timely promotions or no promotions. If you have enough time to benefit for the superior returns (in average during the past decades) of an internationally diversified stock portfolio, Accumulation 2 appears to be the better choice.

• If you choose Accumulation 2 at a young age, make sure that your contributions are invested with high expected returns. The key advantage of Accumulation 2 is the higher expected returns for an internationally diversified stock portfolio. If there is enough time until retirement (such as 30 years and longer), downturns and market crashes are not a problem (and must be expected) for achieving high returns of 4-6% p.a. (after inflation). However, in order to achieve such returns, it is imperative to choose an appropriate riskier (i.e., more volatile) investment options with a high percentage of stock investments or similar.
  Suggested portfolio: An internationally diversified stock portfolio (trying to approximate the FTSE All-World index) can be constructed by combining UniSuper's investment options "International Shares" and "Australian Shares". A rough approximation of the FTSE All-World index would be 97.5% "International Shares" (covering USA, Europe, Japan and China) and 2.5% "Australian Shares". Depending on personal preference, one can also put additional weight on "Australian Shares", "Global Companies in Asia" and "Global Environmental Opportunities", but one should be careful not to fall for a home bias (putting too much weight on Australia despite its small size in the world economy) or recent history bias (putting to much weight on environment opportunities, because they performed well over the last few years).

• DBD is excellent for older hires and those who expect late promotions. If you have less time until retirement or expect some significant promotions in the last few years before retirements (including some higher paid university positions, such as department head or dean), DBD will likely be the better and more predictable option.

• DBD adds predictable returns and potentially stabilizes an already diversified portfolio. If you already have an internationally diversified stock portfolio (from previous superannuation savings or private investments), DBD may add some useful stability with a more predictable growth and cashflow.

• DBD is not a good choice if you expect to leave academia early, but maybe a decent choice if you plan to leave just after being promoted to some higher level (such as full professor). For most salary levels, it is rather unattractive to choose DBD if one intends to leave academia soon. However, if one expects to be promoted quickly DBD can actually lead to excellent returns when leaving or retiring within a few years of receiving significant promotion (full professor or even higher paid university positions).

• Optimize your super contributions before the end of each Australian tax year (ending in June). It may be well-worth it to spend a few hours at the beginning of June to decide how much additional super contributions you can afford to make. For this, you should take your total expected employment income, potential deductions and additional investment income (such as dividends from private investments) into account to determine your marginal tax rate. At the same time, you should check if your pre-tax contributions are below the current concessional contributions cap (including carried-forward concessional contribution caps from previous years) and then decide if you should contribute more. If you made any after-tax contributions (in case of Accumulation 2), you can inform UniSuper that you intend to claim on your next taxes, which effectively converts them to pre-tax contributions, such that they will count towards your concessional contributions cap.
  General tip: If your earnings are just a bit above a new tax bracket, it might be advantageous to just make enough contributions, such that your marginal tax rate drops to the one of the lower tax brackets.

• You could consider to regularly roll over funds from UniSuper to another super fund that provides low cost index funds.
  Overall, UniSuper's investment options are not very expensive, but also not cheap. Choosing a diversified portfolio with international shares will yield an average cost of 0.5-0.7% p.a. There exist other super funds, where the expected annual fees are rather of the order of 0.1-0.2% by investing into worldwide diversified index funds. However, the 14% or 17% university contribution will only be given if one uses UniSuper, so changing your super provider directly is not possible. Instead, you could regularly (e.g., annually) roll over the majority of your Accumulation 2 account to another super fund, so most of your investments would benefit from the potentially lower fee. We only mention this option as a possibility if you believe that low cost index funds will beat more active investments in the long run.

Frequently Asked Questions (FAQs)

• Did you take the yearly growth of salaries into account? We assumed that salaries and other relevant quantities (such as tax brackets and concessional contribution caps) will roughly grow with inflation. Therefore, we considered everything based on the relevant amounts in the tax year 2020/2021. At the same time, we also only quoted investment returns of 4-6%, which we compared to the typical stock market returns AFTER inflation. If higher education salaries grow much faster than inflation, it would likely be advantageous to DBD members, but this does not necessarily mean that the number change dramatically, as the additional salary growth will also contribute positively to the Accumulation 2 contributions.

• Did you take the yearly change of the concessional contributions cap into account? No, we calculated everything based on the numbers of the tax year 2020/2021, because we assumed that also the concessional contributions cap will grow in average in line with inflation or some consumer price index (CPI).

• Did you take the insurance benefit into account, which is built into DBD? Yes, we accounted for this benefit by subtracting 1.5% of the total annual pre-tax salary from any Accumulation 2 contributions. If you believe that the actual cost should be higher you can change the model by making a copy of the spreadsheet and changing the respective assumption.

• Did you take the tax benefit of DBD vs. Accumulation 2 into account, where DBD members can contribute more at a lower tax rate due to the notional taxable contributions (NTC) being typically lower than the actual contributions of a comparable Accumulation 2 member? Yes, we deducted from the contributions of a Accumulation 2 member the relative tax advantage that a DBD member has, which may enable this DBD member to potentially contribute more to their Accumulation Component at the 15% tax rate than an Accumulation 2 member could do on top. Therefore, we assumed that the respective DBD member uses the maximal advantage.

• Did you take into account that DBD members actually also contribute towards an Accumulation Component that is invested on the stock market? We could ignore this because we only analyzed how the money contributed towards the Defined Benefit Division would have grown in Accumulation 2, i.e., we compared apples with apples.

• Did you take the annual investment fees for Accumulation 2 members into account? We did not subtract any fees, but we calculated the Accumulation 2 outcomes for the rather conservative estimates of an annual return of 4%, 5% and 6% after inflation and fees. Average returns in the past were around 6.5% with 90% of the past 40-year-periods yielding 4.9% p.a. and 50% being above 6.4% p.a. (all numbers are based on the S&P500 index). In the end, there is always some risk involved, but we expect that based on past history it is very likely that Accumulation 2 investments will return above 4% p.a. after fees, if one chooses a broadly diversified stock portfolio with a large portion of international shares.

• Do average values not underestimate a long market crash, when Accumulation 2 will perform much worse? In principle, we agree that our conservative estimates of a Accumulation 2 return of 4-6% p.a. does not take the worst cases into account. However, the DBD funds are also invested in worldwide share markets, so a market crash may also affect DBD members, as there is no backing by the government or public employers, so if the DBD funds are insufficient to cover the cost, the DBD benefit may be reduced. It is true that generally Accumulation 2 members will be affected more in a market crash, but they will likely also be able to benefit more from a recovery.

• Did you know that DBD members can reduce their contributions and how will this affect this comparison? You can reduce the after-tax contributions in steps indicated by the sheet contribution factors. For example, reducing the after-tax contribution form 7% to 4.45% does not reduce the DBD return at all, because instead the 3% employer contribution towards the Accumulation Component is now redirected to your DBD component. In effect, you would actually be still contributing the equivalent amount into DBD. If you reduce the amount further, your DBD component will shrink, but you may have more money that you could invest into the Accumulation Component. We did not analyze this case further, as we do not expect that the result will materially change the comparison DBD vs Accumulation 2. Based on our analysis, it could potentially be beneficial to reduce the total DBD contributions and instead contribute more to the Accumulation Component, but we did not analyze this szenario for now. This would mostly be relevant for young members, who would have liked to switch to Accumulation 2, but missed the deadline.

• Your numbers seem to indicate that Accumulation 2 is often better than DBD. Is this correct? Yes, this is also our understanding, but we are no financial advisors and only share our calculations.

• I missed the two-year deadline, but would like to switch to Accumulation 2. What can I do? First of all, let us emphasize that DBD still appears to be a good retirement savings product, whose advantage certainly is that you do not need to do much thinking (what investments to choose, what market volatility to expect etc.). Even if we find that the expected return of a worldwide diversified stock portfolio in Accumulation 2 is often better than DBD, it is still a very competitive product when compared to many other countries and their retirement products for people working in the university sector. Unfortunately, once the two-year deadline has passed, the only option to move from DBD to Accumulation 2 would be to resign, roll over your account into another super fund and then get rehired. If you move from one university job to another, you may need to leave a gap that gives you the time to roll over your super fund, before then getting another two-year deadline when re-enrolling into UniSuper at the new job. We do not recommend such an approach and you should carefully discuss such a choice with a financial advisor and/or UniSuper.