Proposed cap on exit payments in the public sector – taking the pension strain

The Government has resurrected its plans to cap the termination payments for exiting employees in the public sector.

Many had hoped that these plans had been shelved, but the Government, by launching a consultation exercise in April of this year, has demonstrated its intention to see this through. However, there is still a lack of clarity around how this will affect pensions, as this briefing will highlight. We have previously commented more generally on the consultation, and a copy of that briefing can be found here.

For pension advisers and employers whose members contribute to the Local Government Pension Scheme (LGPS), this proposal could have a significant impact on exit arrangements, as the proposed cap of £95,000 includes pension strain payments. The Treasury defines these payments as “payments made by an employer as an additional contribution to a pension scheme in respect of an individual’s exit, so that that the individual receives a greater pension than they would otherwise be entitled to”.

LGPS and the termination payment cap

Under the LGPS rules, employees aged 55-or-over who are made redundant must take their pension benefits immediately. These benefits are not reduced for early payment and the employer is therefore usually required to make an additional lump sum “strain” payment to compensate the pension fund for having to pay the pension benefits earlier and, most likely, for longer.

The cost of these payments can be tens or hundreds of thousands of pounds, depending on the employee’s age and the value of the pension benefits that they have built up. With other forms of early retirement (including flexible retirement), there would normally be a reduction in benefits to reflect early payment. Employers can, however, choose to waive this reduction – but at the cost of a strain payment.

This puts the LGPS regulations and the proposed cap of £95,000 on a collision course before the latter even gets past the drafting board. The Government made some changes to the LGPS regulations in 2016 to address this but these have not yet been brought into force. The intention is that, where the £95,000 cap would otherwise be breached, then an employee’s pension benefits would be reduced to ensure that there is no breach. Employees would be able to make a payment from their own pocket to buy out some or all of the reduction.

There could be some unintended consequences with these changes, for instance, if the changes to the LGPS rules are not brought into force at the same time as the exit payment cap. In those circumstances, if the strain payment to cover early pension on redundancy cannot be paid in full and there is no law authorising reduced benefits in those circumstances, then it is not clear if pension benefits could be released at all.

Even if the rules around partial reduction of pension are brought in, it isn’t clear how any partial reduction would be calculated. Currently, strain costs are calculated locally by each fund – which could lead to different treatment of employees in different geographical areas. It also raises the prospect of someone being forced to take a reduced early pension on redundancy, as currently employees who are 55-and-over have to take their pension on redundancy. This could mean that, as well as being made redundant, employees have to re-jig their retirement plans.

We await the Government’s response to the consultation and hope that they will look to address these anomalies. If you would like to be involved in the consultation and raise these issues, please do use our guide to getting involved and responding to the draft regulations.

We await the results of the consultation and will, of course, keep you informed.

Further information

For more information, please contact Doug Mullen.