Magazine article Government Finance Review

Squeezing Budgetary Savings from Early Retirement Incentives

Magazine article Government Finance Review

Squeezing Budgetary Savings from Early Retirement Incentives

Article excerpt

In today's poor fiscal climate, it seems that every state and local budget officer is being asked to miraculously part the Sea of Red Ink. The National Association of State Budget Officers projects that fiscal 2003 budgets will be even worse than those of fiscal year 2002, which were considered "severely strained." Looking ahead, state governments forecast large revenue gaps in fiscal 2004, including four states in which general fund revenues are expected to lag expenditures by 20 percent or more. (1) Cities are also experiencing severe budgetary pressures, according to the National League of Cities' 2003 Survey of Fiscal Conditions.

To deal with the financial flood, many governments have already implemented "macro" strategies such as across-the-board expenditures cuts, reductions in state-local revenue sharing, and the depletion of rainy day contingency funds. As governments move down the list of budget balancing options, "micro" strategies (those that use targeted approaches to realize budgetary savings) will increasingly come into play. This article discusses the use of one such strategy-early retirement incentives--and suggests techniques for ensuring that these incentives redound to the benefit of taxpayers.

For the purpose of this article, early retirement incentives are defined as temporary incentives or "windows" that alter the normal retirement benefit, typically requiring an amendment to state or local law. In contrast, a normal retirement benefit is the permanent benefit typically available to any employee meeting the requirements of the pension plan. Although normal retirement benefits often include a provision for retiring at a relatively young age, the benefits are usually reduced to offset the economic cost of early retirement incurred by the government. A common practice is to reduce the amount of the pension by a fraction of a percent for each month prior to the normal service retirement age. ERIs effectively offset those penalties during the window in which they are in force.

ERIs can be structured in a variety of ways, as shown in Exhibit 1. The Illinois Municipal Retirement Fund, for example, allows participating municipal employers to offer their employees a "5+5" ERI. This enables employees to purchase (with their own resources) up to five years of service credit and add 5 years to what IMRF recognizes as their age for the purpose of determining eligibility for a normal pension. Because retiree health care is a concern, some governments offer health care subsidies instead of or in addition to such provisions.

Exhibit 1: Types of ERI Incentives

* Adding years of service, for determining the level of pension

* Adding years of service, for determining the eligibility for
a normal (unreduced) pension

* Lump-sum payment

* Increase in the lump-sum payment of sick leave

* Stream of payments for a fixed period

* Permanent increase in the stream of payments (via an
increase in the benefit multiplier)

* Direct payment of retiree health care premiums

* Funding of a savings vehicle for health care costs


In establishing early retirement incentives, governments need to specify the primary objective the program is designed to achieve. Fundamentally, this requires that financial managers establish priorities between gap closing objectives and human resource objectives. While the current fiscal environment might suggest that budgetary savings should be the overarching goal, early retirement incentives are often used to achieve HR objectives. Common HR objectives include creating opportunities for promotion, encouraging the departure of employees who are perceived to be less productive (whether accurate or not), making organizations less "top heavy," and enabling the restructuring of departments.

If HR goals are the primary objective (or even a subordinate objective, for that matter), it is important to consider whether early retirement incentives will conflict with other features of the retirement plan. …

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