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Solvency issues for DB pensions

defined benefit pensions solvency

The negative impact COVID-19 has had on investment markets could result in solvency issues for SMSFs with complying defined benefit pensions, a leading actuary has said.

A senior actuarial executive has warned complying defined benefit pensions held within an SMSF could face solvency issues due to the declines in capital and income generation from investment markets as a result of the coronavirus pandemic.

“Our actuarial valuations assume the fund’s assets will return a certain amount each year which is going to contribute to the funding of [any defined benefit contribution] pension payments. And where the actual returns are lower than assumed, it’s going to cause a funding strain,” Accurium general manager Doug McBirnie said during the actuarial firm’s technical webinar held today.

“Where asset values actually go backwards, that strain is going to be even worse and it can result in the pension not having sufficient capital to remain solvent.”

According to McBirnie, this presents a significant problem for SMSFs as the members of these funds are not permitted to contribute monies to the super fund to replenish the pension capital pool, or pension reserve, of a defined benefit pension.

As such, when faced with this situation, SMSF members will have no choice but to commute the existing defined benefit pension and use the proceeds to commence a new market-linked pension in the fund or roll the proceeds into a retail product, such as an annuity or market-linked pension, outside of the fund.

Further, McBirnie identified another issue that might arise in the circumstances.

“[Defined benefit] pensions with an asset test exemption where the capital is less than the high probability of [covering] that liability, but is more than the best estimate liability [determined by actuaries], can continue to be paid, however, they’re going to lose their asset test exemption going forward,” he noted.

“That can have significant consequences for the amount of age pension a member can receive.”

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