UniSuper's DBD vs. Accumulation 2
The goal of this guide is to give the required information and tools to understand the expected return of the Defined Benefit Component of UniSuper's Superannuation fund. This information is particularly useful for young researchers joining the Australian university system, who have two years after joining to decide if they want to stay in the default system of the Defined Benefit Division or if they rather want to swap to the Accumulation 2 option, where member contributions are invested in the stock market.
Most importantly, we try to compare how the "defined benefit" grows over time compared to investing with a fixed annual return. We try to derive a list of comprehensive suggestions.
The content of this page was written in June 2021, so it is important to verify that nothing has changed. This is not financial advice, so you should do your own research to confirm if you agree with our findings.
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.
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.
Defined Benefit Division
Value ("Defined benefit") is computed based on a fixed formula depending on average salary of the last fives years, time as member, age and a few other criteria. The value can only go up, but with a return of typically 2-3% p.a.
The DBD also includes a (small) Accumulation component, which behaves just like Accumulation 2 and you can choose how your money is invested.
There is a formula to compute the Notional Taxed Contributions which typically means that DBD members can contribute more before hitting the concessional contributions cap and may save more on taxes.
Any pre-tax or after-tax contributions are final, i.e., you can only make changes for future contributions.
The DBD membership comes with built-in insurance cover, which includes disablement, temporary incapacity, suffering a terminal medical condition and death. You can only partially opt-out by reducing your default employee contributions.
If you reduce your default employee contribution to DBD, you will not be able to increase them later on. However, you can always make contributions to the Accumulation component.
Additional personal contributions (on top of the default employee contributions) and roll-overs of other superannuation funds go to the Accumulation component.
You only have two years after starting a position with DBD to decide if you want to switch to Accumulation 2.
Your benefit is not guaranteed, i.e., if UniSuper struggles to achieve the expected return on their investments, they may reduce your "defined benefit" by adjusting the formula.
The standard is that 14% of employer contributions and 7% default employee contributions go towards the DBD, while 3% of employer contributions go towards the accumulation component (which behaves just as Accumulation 2). However, if you reduce your default employee contributions, more employer contributions go to the DBD.
Value is based on the chosen investment options and may significantly fluctuate depending on this choice. Based on past returns, an internationally diversified stock portfolio can yield 4-6% p.a. in average when one invests for long periods.
For Accumulation 2, you can choose how your money is invested based on a selection of pre-mixed options covering worldwide stocks and other investable assets.
There is a strict concessional contributions cap that limits how much members (and their employers) can contribute per year. Any additional contributions will be effectively after-tax contributions, as they are taxed at your marginal tax rate.
After-tax contributions can be converted into pre-tax contributions (by claiming them), but not vice versa.
You can choose your own insurance cover whose cost will be deducted from your contributions/returns. This allows you freely choose the required cover depending on your personal circumstances at that point in life.
You can freely reduce or increase your employee contributions, which all go towards your chosen investment selection.
Any additional personal contributions (on top of the default employee contributions) and roll-overs of other superannuation funds are invested in the same way.
Once you chose Accumulation 2, you cannot switch back to DBD unless you quit your job and are hired again.
There is no guarantee for the respective investment returns, so you can only make your estimates based on past performance of your chosen investment options.
17% of employer contributions and all your own pre-tax or after-tax contributions are invested equally. There is only an accumulation component.
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
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. In particular, we use a concessional contributions cap of 25,000 AUD throughout our calculations.
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 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 7% pre-tax. This corresponds to the current standard setting, 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.
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 soon. If you are hired on typical entry levels (Lecturer or Senior Lecturer) at a relatively young age, DBD actually has a negative return in the first few years. When a researcher decides to swap from DBD to Accumulation 2, the transfer amount is computed based on the DBD formula, such that this negative return may lead to a loss of up to 1,500 AUD compared to an immediate transfer (without taking opportunity costs into account, as the respective amount also could not produce any returns). The situation is different for older hires on higher levels, as the DBD may give decent to excellent returns in these cases, so that there is less incentive to act quickly. In summary, we recommend for young hires on entry levels to carefully compare DBD and Accumulation 2, so that they can make their decision within the first few months of having the option (rather than waiting up to two years)!
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.