The early retirement scheme for public servants announced in the Budget this week may seem like a win-win proposition, but is it really as attractive as Brian Lenihan would lead us to believe, asks CAROLINE MADDEN.
AT FACE value, the early retirement scheme for public servants announced in the Budget seems like a win-win proposition. Public servants get to quit the day job up to 15 years early without a nasty “actuarial reduction” making a dent in their pension, while the Government gets to curb its pay bill.
But is it really as attractive as Minister for Finance Brian Lenihan would lead us to believe, and how much will it actually save the State?
To answer these questions, it is necessary to examine how exactly the scheme will operate when it opens for applications on May 1st.
HOW WILL IT WORK?
Under the new scheme, “eligible” civil or public servants aged 50 or over will be able to retire and receive an immediate pension, without actuarial adjustment.
Public-sector workers are entitled to a pension of 1/80th of their final salary for each year of service, up to a maximum of 40/80ths, or 50 per cent, of their final salary.
Lump-sum entitlements are determined on the basis of 3/80ths of final salary per year of service to a maximum of 120/80ths.
Under this scheme, those retiring early will also be entitled to take 10 per cent of their tax-free lump sum payment immediately, with the balance payable at the normal retirement age of 60 or 65.
The major benefit of the early retirement scheme for the individual is the fact that the individual’s pension entitlements are not subject to an actuarial reduction. This adjustment – which effectively reduces the pension – takes account of the fact that people who retire early will, in all likelihood, receive a pension for longer than those who retire at the normal age.
Michael Madden, an actuary with pensions consultancy Mercer, says that in a private-sector pension scheme, the actuarial reduction factor would be between 4 per cent and 6 per cent per year if an employee retired early. So if, for example, a person retired five years early, they would typically only get about 80 per cent of their accumulated pension entitlement whereas, under the new public-sector early retirement scheme, successful applicants would receive 100 per cent of their entitlement.
So if someone in the public service with 25 years’ service retired five years early, they would generally receive a salary of 20/80ths rather than 25/80ths under actuarial adjustment. Under the scheme announced by Lenihan, they would receive the full 25/80ths accrued.
If the offer of an undiscounted pension is the carrot to entice public servants into retiring early, then the heavy hint in the Budget speech that pension lump sums will soon become taxable is the stick.
Lenihan made it clear in his speech that pension lump sums of those who avail of this scheme will remain “subject to current tax law provisions”.
So even if such lump sums become taxable in the 2010 budget – a distinct possibility given the Minister’s hint – the entire lump sum of those taking early retirement before that date will remain tax free, even though 90 per cent of it will not be drawn down until their normal retirement age.
WHO CAN AVAIL OF IT?
The Government has been characteristically vague as to who exactly will be eligible for this scheme.
“The scheme will apply generally to staff serving in the Civil Service, local authorities, the health and education sectors, and non-commercial State bodies,” according to the Department of Finance.
However, it will not generally apply to areas where there are already options for early retirement. For instance, gardaí and firemen can retire early because of the nature of their work. Nor will it apply in areas where it is Government policy to replace staff to ensure the continued delivery of a service, for example teaching. In an annex to the Budget, the department says the scheme “will be subject to local management arrangements and controls to ensure that its operation does not undermine the effective delivery of services to the public”.
But, as for specific details of the workings of the scheme, public-sector employees will have to wait for further communication from the department.
IS IT WORTH TAKING?
There are pros and cons to consider but, for public-sector workers with long service, for example 30 years, this could be a good deal.
Pensions Ombudsman Paul Kenny feels the scheme will be attractive to public-sector workers “fed up” with paying the pension levy and possibly higher PRSI (as a result of the Budget). The scheme will be very attractive, “if somebody says, ‘look, I’m quite happy with a pension of 30/80th [if they retire early with 30 years’ service] of my pay rather than 40/80th; I can go to Mayo and fish’”.
They will have to wait several years for 90 per cent of their lump sum but, “in the meantime, they get out of the paying the pension levy”, he says.
The combination of avoiding the pension levy and being able to retire early without an actuarial reduction “has to be attractive to a lot of people”, he concludes.
And, of course, there is nothing to stop people using the opportunity to launch a change in the direction of their career, although the current job market might make that a bit of a challenge.
However, Ian Mitchell, managing director of Deloitte Pensions and Investments, says the scheme falls down in one key area. Those who avail of it will only receive 10 per cent of their pension lump sum when they retire, and will have to wait until normal retirement age – possibly another 15 years – for the balance.
If a public servant on a salary of €50,000 retires at the age of 65 after 40 years of service, they will receive an annual pension of €25,000 (40/80ths). Mitchell points out that, although this represents a “big drop” in their income, they will also get a tax-free (under current tax rules) lump sum of €75,000.
However, if this person takes early retirement at 55, their annual pension will fall to €18,752 (30/80ths), and they will only receive a tax-free lump sum of €5,625 at that point. They will have to wait until normal retirement age for the balance of €50,625.
Normally, when a person retires, their tax-free lump sum cushions the blow of moving on to a substantially lower income. For example, they can reduce their overheads by using the cash to clear down debt. But if they only receive 10 per cent of the lump sum, this is not possible. The scheme would be more attractive if the Government had offered 50 per cent of the lump sum up front, or even a staggered payment, Mitchell suggests.
Those considering availing of the scheme should also remember that the State pension does not kick in until the age of 66, so they will have to decide whether they can survive on a reduced income until then, or else consider taking up some kind of employment when they retire from the public service.
HOW MUCH MONEY WILL IT SAVE?
One figure that is conspicuous by its absence in the Budget material relating to the early retirement scheme is how much it will save the Government. In fact, there is no estimate for the savings that will emerge from the scheme in isolation, according to a Department of Finance spokesman.
“The expenditure figures in the Budget include payroll savings of €150 million in 2009 and €300 million in a full year for all the measures announced . . . on early retirement, special incentive career breaks and a shorter working year scheme, as well as the general impact of efficiency measures by departments and bodies,” the department said.
Reducing staff numbers, and therefore payroll costs, will have an immediate cashflow benefit for the Government coffers. However, Madden says, “the true cost will only be felt in the long run”, as public-sector pensions are operated on a “pay as you go” basis, rather than accounting for the full capital cost up front.
“In view of the increases in life expectancy experienced in recent years, the cost of this measure [as yet uncosted] could prove to be very significant,” pensions firm Watson Wyatt predicted in its Budget commentary.
“I can’t see that the Government will save huge amounts of money by offering it,” says Paul Kenny.
He predicts that the net boost to Government finances will not be huge, as those who take early retirement will contribute less tax than they would if they had remained in employment.
“While the Government saves the difference between the salary and the pension, the tax take is going to be correspondingly lower as well,” he says.
In the longer term, the scheme may achieve the objective of reducing staff numbers in the public service, but the short-term gain is unlikely to be significant.
One of the effects of the scheme, according to Raymond McKenna of Watson Wyatt, is that it widens the divide between public- and private-sector pensions even further. Even if private-sector employers wished to offer a scheme like this to their staff, they would probably be curtailed by pension fund solvency issues.
Scheme example
UNDER THE new scheme, a civil servant earning €60,000 a year with 30 years' service will leave with an immediate pension of €22,500 (30/80ths of €60,000) and 10 per cent of the lump sum (€6,750 up front). Their total lump-sum entitlement is €67,500 (30 years' service x 3/80ths x €60,000). The balance of 90 per cent is payable at their normal retirement age.
Before the Government's new measure, the actuarial reduction (which takes account of the fact that people who retire early receive a pension for longer) for a retirement at the age of 50 would have cut the pension to €14,040 and the lump sum to €55,485, all of which would be payable immediately on retirement.
Information provided by the Department of Finance
