Looming exit payment cap puts extra strain on LGPS funds

The £95,000 cap was first mooted in 2015 to ensure exit payments present value for money to the taxpayer, following public outrage over six-figure payouts. Recently, a payout to departing top civil servant Mark Sedwill attracted significant media attention.

But the new rules could also ensnare members of the Local Government Pension Scheme, including those on much more modest salaries, and create new headaches for the scheme’s partner funds, experts have said.

I hope the changes to the LGPS regulations will give people beneficial choice that still enables employer restructures to go ahead with consent, but not make it too complicated for administrators or members

Jeff Houston, LGPS Scheme Advisory Board

A redundancy pension in the LGPS is currently paid unreduced to active members who are made redundant at age 55 or over. This cost is typically met via a pension strain cost that the employer has to pay into the fund.

The changes would limit the pension payable on redundancy, by applying the actuarial reduction necessary to bring the cost within the cap.

LGPS needs guidance

Little has changed in the draft regulations published on July 21 compared with the 2019 consultation, but details are lacking as to how the cap will work in practice. 

Jeff Houston, secretary to the LGPS Scheme Advisory Board, expects the regulations to speedily pass through parliament.

He says: “The regulations are affirmative, which means they will need to go through both houses. We have been made to understand that the Treasury would like to see these rules come into force by the end of the calendar year.”

The regulations provide for the cap to be introduced 21 days after they are made. The LGPS is now awaiting guidance from the Treasury on how the cap will work in practice. It will also require changes to the LGPS regulations, on which Mr Houston expects a consultation in the next couple of weeks.

One area of uncertainty that needs to be clarified by the Treasury is where members agree to leave before the cap comes into force, but may not actually leave until afterwards.

“People who would be hit by the cap will be on three-months’ notice at least, so conversations around things like voluntary redundancy are probably already happening. Are these people going to get a reduced pension or a full pension?,” asks Mr Houston.

Actuarial factors vary

Another quirk is that different LGPS funds use different early retirement factors to calculate the cost of a reduced pension. 

Barry McKay, partner and fund actuary at Barnett Waddingham, says that under the exit cap, LGPS funds would probably use the same set of factors provided by the Government Actuary Department to avoid a postcode lottery.*

“For example, if someone retires at 55 in Glasgow they should be treated in a consistent way to somebody of the same age taking redundancy in London. Otherwise, one person could end up breaching the cap while the other could be under the cap,” he explains.

But Douglas Green, partner and actuary at Hymans Robertson, warns this would create issues. “Those standardised factors might not be the ones that you’d want for funding purposes to make sure the employer is plugging the right amount of cash into the fund,” he says.

“One LGPS fund might end up charging the employer a very low sum of money, and conversely another fund could charge an employer a high sum of money. This is why funds use different factors.”

Tough choices for members

Experts warned back in 2015 that the cap would catch members who are not even high earners. Barnett Waddingham estimates a member earning £40,000 with 25 years of service would breach the £95,000 limit, as would a member on £30,000 with 35 years of service. 

There is no intention to index the cap to the consumer price index, which would increase it to £110,000, although the Treasury’s response said it would be kept under review.

Mr Green says: “The cap catches people on middle-income salaries but have been in the LGPS for enough years to build up a reasonably sized pension, even though they’re not a high earner.”

Members will be faced with some difficult choices, according to Mr Houston: “The LGPS regulations could include options to introduce choice for members to take a deferred benefit rather than a reduced pension, together with guidance on the calculation of standardised strain costs and the option to purchase the shortfall. 

“I hope the changes to the LGPS regulations will give people beneficial choice that still enables employer restructures to go ahead with consent, but not make it too complicated for administrators or members.”

Richard Warden, partner and actuary at Hymans Robertson, points out that it will be even more difficult for middle-income earners to make decisions about their pensions.

“They do not have a lot to fall back on and it’s a tough call to say, ‘I’ll take the cash because I’m redundant and need it and not bother with a pension’,” Mr Warden says. 

While waiting for more details, Mr McKay says administering authorities should start getting to grips with the exit payment cap and communicate with both members and employers to allow them to plan ahead.

*This article has been updated to correct an inaccuracy in the reporting of Barry McKay's position