27
Nov
2017

Need Budget Cuts? Consider an Early Retirement Incentive

Categories: California Developments,Early Retirement Incentives
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School Services of California by Sheila G. Vickers, November 2017

As state revenues for education are slowing down, and as many schools and community colleges are declining in enrollment, we are hearing from many of you in the field that you are looking for ways to reduce expenditures. Given that at least 85% to 90% of local school agency budgets are personnel costs, any significant cuts will necessarily impact personnel. If your agency is in the difficult position of having to consider staffing reductions, an early retirement incentive could be a way to reduce or eliminate layoffs.

The Incentive

An early retirement incentive should function as just that—an incentive for employees to retire earlier than they normally would have. Generally, employees who are eligible for retirement are at the top end of the salary schedule and the employees laid off, or employees who are new hires, are generally at or near the beginning of the salary schedule. The differential in total compensation between the two means that one retirement may save somewhere between one or two jobs for lower-paid employees. Some of that savings can be used as an incentive to draw more retirees than your agency would normally have in a given year.

Because of the structure of the salary schedule for certificated nonmanagement employees, the compensation differential is typically the most significant. For management and classified employees, the salary ranges are structured so that the number of years of service to achieve the highest salary generally are not enough to make an early retirement incentive work financially, unless positions are eliminated or the incentive is combined with an offering for certificated nonmanagement employees.

The Frequency

We still see some collective bargaining agreements in the state that include a provision for an early retirement incentive. When an incentive is offered with certainty, it no longer works as an incentive. An early retirement incentive should only be planned and announced for the year that it will be offered, with no prospects as to when it will be offered again.

An early retirement incentive, if effective, will draw employees who would normally have retired in future years to instead retire this year. This means that, for the following years, the savings from natural attrition—those retirements that would normally have taken place—will be lower due to a fewer number of normal retirements in each year. This is why, in our opinion, an early retirement incentive should not be offered more often than every three to five years, depending on your local circumstances.

The Options

Certificated staff members will often ask specifically for the California State Teachers’ Retirement System (CalSTRS) Golden Handshake program, where the employer can pay the cost of two years of additional service credit in order for the member to retire early. The CalSTRS program can only be offered to CalSTRS members and has additional requirements, such as restrictions on returning to work. This program is generally more costly and less flexible than a program that can be crafted by the local agency itself or through a private provider.

Locally developed plans are generally best at meeting the needs of the employees who are on the cusp of retirement, and can be offered to any and all employee groups. Some employers have offered a tiered incentive to attract retirees to opt out of district-paid medical coverage. Other employers have offered variable length annuities from which retiring employees can choose. Early retirement incentive programs are not “one size fits all” and can be tailored to fit your agency’s unique situation.

The Objective

In order to determine the possible success of an early retirement incentive, the desired outcome has to be defined. Is it a particular budget savings amount that is the goal? Is it a particular number of retirements? Is it retirements in a particular functional area or location of your agency in order to be able to restructure programs or services? Is it all of the above?

Once the desired outcome is defined, the next step is to determine which employees are at or near typical retirement age and have enough years of service—both with the CalSTRS or California Public Employees’ Retirement System (CalPERS) and with your agency—to qualify for retirement benefits. If your goal is primarily financial, remember that you are paying the incentive to all employees who retire, even those that would have retired anyway. So you would need to have enough retirements to reach your financial goal with that consideration. A minimum number of retirements in order for the program to be a “go” should be determined and should be specified in the incentive offer to employees.

The Savings From Attrition

Every year, the typical school agency experiences savings from normal attrition—the effect of employee turnover on the natural from retirements, resignations, and other occurrences that result in new hires with a lower compensation cost. School agencies typically account for this in each year’s budget process by offsetting the cost of step and column movement.

When an early retirement incentive is offered, the savings from the attrition effect for the normal number of retirees should not be counted again as new savings—this is a danger zone that has caused trouble for many agencies. Only the additional savings above natural attrition—the total savings as a result of the early retirement incentive less the typical annual attrition savings—should be counted as new savings. Otherwise, you will have a significant budget surprise the next year if you double counted natural attrition savings.

The Calculations

The employer can calculate the cost/benefit of different benefit levels and varying assumptions as to how many positions are replaced, how many and which employees retire, etc. A private provider will have this process automated and can generate scenarios based upon assumptions that you verify. Your agency should take ownership of any assumptions provided and used by the private provider.

The additional savings from attrition—total attrition savings minus natural attrition savings—is the financial benefit side of the equation for your agency. The cost side of the equation is determined by calculating the following:

  • A realistic number of retirees who are likely to take the incentive
  • The cost of the incentive, including the payments for the incentive, administrative costs, and other expenses resulting from the incentive offering
  • The cost of postemployment benefits for the retiring employees
  • The cost of the replacement employees’ salaries and benefits for those positions that will be filled
    • Note: For each position that will not be filled, the Board should take action to eliminate the position once the retirement is known

These factors should be projected for subsequent years, taking into account that replacement employees will likely be receiving increases due to step and column movement, and that your agency’s contribution to health benefits may also be increasing.

If your calculations determine that your agency’s financial and staffing goals can be met by offering the incentive, then remember, as you design the incentive, to establish the threshold number of retirements that must occur in order to reach your financial goal. If that threshold is not reached, give your agency the option to offer the incentive anyway or to allow employees to rescind their retirement.

The Window Period

If your agency decides to offer an early retirement incentive program, and you want to have retirements in hand before having to make a decision regarding potential layoffs for next year, it’s time to get started with the tasks above and to open a window period soon for employees to consider the incentive. Ideally the window period would last 45 days or longer. This would provide time for employees to have discussions with family, seek retirement counseling, and otherwise conduct their due diligence before deciding whether to retire. Remember that the point of an early retirement incentive plan is to attract additional retirements. In order to do so, employees must have adequate time and information in order to make an appropriate decision for themselves.

The Potential Side Effects

Whenever reducing staffing costs, local school employers have to be watchful of the side effects. For K-12 school districts, there could be an impact on compliance with the minimum classroom expense requirement. For community colleges, compliance with the full-time faculty obligation or the 50% law calculation could be impacted. Our advice is to model the possible results of an early retirement incentive so that your agency will be prepared to address the issues in these areas, if any.

Conclusion

Many local educational agencies are having to consider reducing staff to address deficit spending and/or declining enrollment. If an early retirement results in not having to backfill the position, the financial aspects of the plan improve. Your agency may also avoid layoffs of junior staff.

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