The budget only announced that unfunded taxable defined benefit pensions in excess of $100,000 annually would be subject to an additional 10 per cent tax, while 50 per cent of funded pensions in excess of this amount would be added to the taxpayer's assessable income.

Only a relatively small number of PSS members receive annual pensions in excess of $100,000. But for those who do, the pension in most cases includes both funded and unfunded components and the additional tax payable varies with which component is applied first against the $100,000 trigger point.

When there are mixed benefits, the additional tax on the funded component (subjecting 50 per cent of the income above $100,000 to marginal tax rates) will be more than the additional 10 per cent tax to be levied on the unfunded pension above $100,000.

Just how much larger the additional tax bill on the funded component is depends on the taxpayer's marginal rate. At the marginal rates applying above $100,000 of income, the tax applicable is 19.5 per cent (which is half 39 per cent).

If the legislation does not allow the funded tax-free component to be counted first against the $100,000 trigger point of the new tax, the additional tax payable on the funded component of defined benefit pensions will in many cases be 19.5 per cent or even higher.

This is a particularly important issue for retired federal employees because the larger part of their employer defined benefit payments are unfunded. Receiving unfunded taxable income ensures the marginal tax rates on any other income they may receive is higher than those applicable to funded pension recipients who, after age 60 until the new rules apply from 1 July, 2017, pay no tax on their pensions.

The new arrangements will continue to favour funded tax-free pension recipients because after age 60 the first $100,000 of their annual defined benefit pension income will continue to be excluded from assessable income. As a consequence, the new rules will not result in any additional tax on annual funded defined benefit pension of up to $140,000 (after age 60) or $157,000 (after age pension age) when they have no other taxable income.

This is the case because the assessable income of 50 per cent of their pension over $100,000 would be below the tax threshold. Recipients of annual unfunded defined benefit pensions of $140,000 and $157,000 already pay $28,500 and $33,500 in tax and will be subject to additional tax of $4000 and $5700 when the changes are introduced.

Daryl Dixon is the executive chairman of Dixon Advisory. comments@dixon.com.au