01
May
2020

Dos and Don’ts of Using Voluntary Separation Incentives as a Fiscal Tool in Pennsylvania

Categories: Early Retirement Incentives,National Developments,PARS News
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As published in the May 2020 PASBO Report…

by Maureen Toal, PARS Senior Vice President, Consulting

A well-crafted early retirement or separation incentive can be a win-win approach for management and employees/labor to achieve fiscal savings, avoid layoffs, and restructure departments or positions. The key to constructing a successful incentive is considering when and how it should be implemented. Below are crucial points to examine:

DO Properly Analyze Whether an Incentive Will Work

One of the biggest mistakes districts often make is failing to properly analyze the costs of an incentive over multiple years, thereby implementing a program that does not truly save dollars over the long-term. A key focus of any incentive, therefore, is to ensure that a comprehensive analysis is conducted that takes into account costs such as PSERS, retiree health care, natural attrition, and the incentive itself. The likelihood of plan success should also be analyzed based on different benefit offerings, current workforce demographics, and the re-staffing needs for projected retirements.

DO Only if You Can Beat National Retirement Attrition

An early retirement/separation incentive only works, and creates savings, if a district offers enough of an incentive to significantly exceed natural retirement attrition in any given year. This means that if you typically have 10 retirements in a year, you will likely need to incentivize at least 20 or 25 employees to leave in order to achieve savings. This is because the first 10 employees would have retired regardless which means they must be considered a cost in the analysis, not a savings.

DON’T Do if Salary Differentials are Small

Retirement incentives generally focus on near retirement-age employees that are clustered at higher salary levels and protected by seniority. Cost savings are achieved by replacing these employees with those that are lower on the salary scale (such as entry-level employees) or by eliminating certain positions altogether. Larger salary differentials, commonly seen with teachers, make the savings happen, whereas narrow salary differentials can often cause an incentive to cost money, rather than create savings.

DON’T Offer a Cash Incentive

Retirement/separation incentives in Pennsylvania school districts are often offered as a one-time, lump sum “cash” payout option. This has distinct drawbacks: Uncle Sam takes a large portion of the benefit upfront, employers are subject to paying payroll taxes on the benefit, and the incentive itself must be paid in one lump sum, which puts a great strain on the budget. There are more valuable alternatives that should be considered prior to implementing
a cash incentive.

DO Use a Tax Deferred Vehicle

Instead of a cash offering, consider a locally-controlled tax qualified retirement vehicle, such as a 403(b) plan. School administrators in Pennsylvania are sometimes unaware that changes in 403(b) rules well over a decade ago allow employer to employee contributions for 5 years post employment, making it an ideal tax deferral vehicle for an early retirement incentive that can supplement PSERS. The employer can also fund the incentive over 5 years for cash flow purposes, and employees gain more flexible distribution options such as IRA rollovers, which typically end up increasing participation.

DON’T Try to Do It All Yourself

Whenever possible, have firms with expertise help your district properly analyze, design, and communicate the incentive. Find an expert in the consulting and design of school district or higher education retirement incentives (not to be confused with 403(b) vendors) that will not only assist your district in the development of the program, but can also handle all of the communication with employees and retirees.

 

Link to digital copy of May 2020 PASBO Report

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