Early Retirement and the Exit Pay Cap

Well this might seem a bit niche. But if you’re in the public sector – especially local government – there is one major issue that you will be concerned with. That is the introduction of a £95,000 cap on public sector exit payments.

It isn’t something that strikes most people as controversial – who cares after all if senior executives are no longer given overly generous redundancy payments?  The maximum statutory redundancy payment is around £16K so anyone getting just under six figures is still doing pretty well.

The crucial point however is that included in the cap is what is known as a ‘pension strain’ payment. This is a payment made by an employer to a pension fund to cover the additional costs of an employee who qualifies for enhanced benefits when taking early retirement.

For example, in the Local Government Pension Scheme (LGPS), an employee who is made redundant over the age of 55 is entitled to an unreduced pension – they essentially get the pension they would have been due if they were at retirement age. The cost of that benefit is not covered by normal pension contributions. Instead the pension fund charges the employer an extra sum to cover the cost. This is the ‘pension strain’ payment and it is this payment that is caught up in the £95,000 cap.

And that is a problem because pension strain payments are very expensive. It is not unusual for them to be well in excess of £100,000 – even for middle ranking employees. If you put the payment alongside statutory and contractual redundancy payments, the cap presents a serious problem for any local authority looking to make redundancies affecting employees who are 55 or over.

So if the cap is to be brought in, it is obvious that the LGPS needs to be changed first. Essentially the pension entitlement of those being made redundant over the age of 55 needs to be reduced. You won’t find that fact highlighted in the news coverage of this issue, but for local government at least this is far and away the most important result of capping exit payments.

Quite rightly, therefore, the Ministry for Housing, Communities and Local Government is consulting on changes to the pension scheme. It proposes that the pension strain cost should be capped at a level that allows the employer to comply with the £95K limit. As a result the employee’s pension will be adjusted in line with the amount the employer is paying. The scheme will be made more flexible so that the employee can make their own payment into the fund to secure additional pension. I think the government may be overestimating how many tens of thousands of pounds employees will have available for this purpose, but that’s a separate issue.

Now it should be obvious – absolutely obvious! – that the cap on exit payments should not be brought into force before the necessary changes to the pension scheme have been made. It would be grossly irresponsible to do otherwise. The MHCLG consultation runs until November the 9th and – rather oddly – consultation on the already published draft Regulations amending the scheme in line with that consultation runs to December 18th. Even assuming a level of speed and efficiency rare in government circles, that suggests that any change to pension entitlement is unlikely to take effect before the end of the year.

Nevertheless, the Government has brought the Restriction on Public Sector Exit Payments Regulations 2020 into force with effect from 4th November. This is a baffling decision and I think the government will come to regret it.

There is no transition period. From 4th November it will be unlawful for a local authority to make an exit payment in excess of the cap. That will be so even if an employee was given notice of dismissal three months earlier.

So what happens to pensions in this limbo period between the cap coming into force and pension scheme being changed? My view is that this is not the employee’s problem. The entitlement of a redundant employee aged 55 or older is set out in Reg 30(7) of the Local Government Pension Scheme Regulations 2013. That provides that such an employee ‘is entitled to, and must take’ an immediate pension ‘without reduction’.

The pension strain payment is dealt with by Reg 68(2) of the LGPS Regs. That says that the ‘administering authority’ – the local authority operating one of the LGPS pension funds – may require the employer to make additional payments to the fund as a result of the employee’s retirement benefits becoming ‘immediately payable’.  

Here is the key point. The employee’s benefits are not dependent on the pension strain payment actually being made. That, after all, is why the government is having to consult over their proposed changes to the pension scheme. The fund is required to charge the employer for the additional costs caused by the employee’s enhanced entitlement, but that entitlement comes first.

So with the cap in place – and before the rules of the pension scheme are changed – the employer is in something of a quandry. It is faced with a request from the pension fund made under Reg 68(2) which is likely to be for a sum that it is legally prevented from paying under the Exit Payments Regulations. My reading, for what it is worth, is that the employer simply has to say to the fund ‘sorry, but we are only legally allowed to pay you this much’. The fund will then have to worry about the shortfall in the funding of the pension that this causes. Not a satisfactory position of course – but not the employee’s problem.

The trouble is, the Government does not seem to see it that way.  The Minister for Local Government has written an extraordinary letter to the chief executives of administering authorities telling them that they will have to limit the pensions paid to employees being made redundant. There is no getting around the need to quote the key paragraph in full:

“In the meantime, the recommended course of action for an administering authority to act consistently with its legal duties is that the provisions of Regulation 30(7) are subject to the cap and so the provisions of Regulation 8 of the 2020 Regulations and Regulation 30(5) of the LGPS 2013 Regulations should be engaged. The Government’s view is that LGPS members in that position should be able to elect to receive an immediate but fully reduced pension or, if they do not so elect, a deferred pension plus a lump sum equal to the capped strain cost.”

The fundamental error in this paragraph is the assertion that the provisions of Reg 30(7) (the entitlement of a redundant employee over the age of 55 to an unreduced pension) are ‘subject to the cap’.

They are not.

The cap is a cap on payments made by an employer to an employee in respect of their leaving employment. The payments included in the cap are listed in Regulation 5. That list does not include payment of pension – whether enhanced or otherwise – from the pension fund to one of its members. Indeed how could it? By no means every local authority operates its own pension fund. Typically the largest local authority in a particular region administers a fund and the surrounding local authorities are ‘participating employers’. So in most cases pension payments are not made by the employer at all. Even where the employer is the administering authority it is clear that the pension payment is not being made in its capacity as employer.

More fundamentally however, the actual pension payments to the employee are modest and spread over time. The employer’s pension strain payment may over £95,000 but it will usually be some years before the actual pension paid to the employee will add up to that amount.

So on what possible basis can the government claim that payments made under Regulation 30(7) are subject to the cap? It is nonsense!

The Minister then says that Regulation 8 (of the Exit Payment Regs) ‘should be engaged’. We need to look at what that says, but I suggest you have a cup of tea first.

I’ll wait….

Right. We need to set out Regulation 8 in full because I have no idea how to summarise it. Here it is:

8.—(1) Where these Regulations prevent a relevant authority from making an exit payment of the type described in regulation 5(2)(b) which exceeds the exit payment cap in respect of a person, the relevant authority must, as an alternative, make to that person or in respect of that person to another person, a payment of an amount not exceeding the amount of that exit payment.

(2) This regulation is subject to regulation 3(a).

Soak it up. Let the words flow over you.

If you are left thinking ‘what does that mean’? then join the club.

The reference to Reg 5(2)(b) is a reference to the pension strain payment that we have been discussing. The Regulation seems to say that if an employer is prevented from making a payment because it exceeds the cap then it must ‘as an alternative’ pay an equivalent sum either directly to the employee or to someone else – presumably the pension fund – ‘in respect of that person’.

But that equivalent payment is in itself subject to the cap (that’s what the reference to Regulation 3(a) means) so this doesn’t solve the problem. It merely seems to allow the same total amount of money to be shuffled around so that some is given directly to the employee rather than the pension fund. But I fail to see what that would achieve.

What the Government seems to think this means – judging from the Minister’s letter – is that the employee has a choice. They can either take a reduced pension provided for by Regulation 30(5) LGPS (which is aimed at former employees who happen to reach the age of 55 and want to take their pension early) or they can defer their pension and receive a lump sum from the employer equivalent to the capped strain cost that the employer would otherwise be required to pay into the pension fund.

This is nonsense. Regulation 8 does not amend the LGPS Regs and those Regulations give the employee no such choice. We have seen that Reg.30(7) says that the employee ‘is entitled to, and must take’ an unreduced pension. They cannot choose to defer it.

They may well have that choice once the LGPS Regs are amended, but to suggest that it is already the position fundamentally misunderstands how laws work. It seems strange to have to point out that just because you intend to introduce a law in the future does not mean that everyone has to behave as though that law is already in force.

I could scream.

My worry is that it is difficult for those administering a pension fund to just dismiss a letter from the relevant minister telling them that they can no longer pay the unreduced pension provided for in the rules of the pension scheme. But if they follow the course of action set out by the Minister in his letter then they seem certain to face legal action from employees who are not given the pension that they are clearly entitled to receive. If the employer has paid the employee a lump sum then they may well choose to put that towards their legal expenses.

I think the Minister needs to withdraw the letter and acknowledge that pension rights cannot be taken away by such indirect means as the Exit Payment Regulations. Treasury Ministers should then make it clear (as they have the power to do) that local authorities can waive the application of the cap when it comes to making pension strain payments until such time as the Local Government Pension Scheme is properly amended.

If this doesn’t happen then it seems inevitable that this will end up in the courts – and I don’t think that would end well for the Government.

To see more of what I do visit Darrennewman.org

For a more detailed explanation of how the exit pay cap works then you might like to watch this webinar that I recorded before the implementation date was known.

About Darren Newman

Employment law consultant, trainer, writer and anorak
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2 Responses to Early Retirement and the Exit Pay Cap

  1. stephengimages says:

    Surely a union will take this one on? Rather than expect members to gamble away lump sum retirement pay on legal fees?

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