Taking the Strain

David Davison

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When faced with cost constraints, considering a reduction in staff is an obvious early consideration. However, for those employers with staff in LGPS great care needs to be taken as ‘strain costs’ imposed by the Fund could result in very significant payments, often well in excess of any salary savings made. So what do you need to look out for?

LGPS provides enhanced benefits to members who are aged over 55, should they be removed from the scheme on grounds of ‘operational efficiency’, so providing protection around dismissal and redundancy. These members are entitled to their retirement benefits (i.e. pension and lump sum) immediately, with no actuarial reduction for early payment with the cost of this increased benefit fully funded for by the employer at the time of the retirement.
Strain costs are calculated as the difference between the value of the benefits the member would have received under the normal course of providing benefits from the Fund, and the value of the benefits provided as a result of un-reduced early retirement due to redundancy.

As an indication the graph below illustrates estimated strain costs at age 55 for a combination of salary and service profiles.

LGPS Bulletin 3 Taking the Strain Graph

So if we take someone, as an example, on a £40,000 salary with 20 years’ past service going at age 55, the strain cost could be in the region of £40,000. A higher salary or increased service period will increase this figure. It is not uncommon to see strain costs in excess of £100,000, so charities need to be watchful in these circumstances to avoid unwelcome surprises.

The Government has recently issued its response to the consultation on placing a cap of £95,000 on exit payments made to those leaving employment in the public sector. It has also released draft regulations regarding this. The exit cap will not come into effect until 31 October 2016, at the earliest. The payment cap will cover payments made in relation to leaving employment, including:

  • voluntary and compulsory exits.
  • other voluntary exits with compensation packages.
  • ex-gratia payments and special severance payments.
  • monetary value of any extra leave, allowances or other benefits granted as part of the exit process which are not payments in relation to employment.
  • payments or compensation in lieu of notice and payments relating to the cashing up of outstanding entitlements (such as outstanding leave or allowances that are cashed up and added to the value of the sum).

Payments made are aggregated before the cap is applied.

This cap, if implemented as proposed, could reduce the strain costs payable, however there could be considerable upheaval in the short term, as staff consider their retirement options prior to any changes being implemented.

So, when considering any staff redundancies make sure you’re totally aware of the implications of strain costs in order to avoid any nasty surprises.

David Davison

Post by David Davison

Specialist consultant on pensions strategy for corporate, public sector and not for profit employers

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