Reform of local government exit payments
The statutory provisions governing exit payments to local government workers are in the process of reform.
This consists of three separate elements:
- The implementation of a £95,000 cap on public sector exit payments, including employer contributions to pension costs. The cap also applies to other public sector workers and came into effect on 4 November 2020;
- Reform of the Discretionary Compensation Payments Regulations (DCPR) and Local Government Pension Scheme Regulations (LGPS) to place additional restrictions on severance payments and limit the amounts an employer can contribute to pension strain costs where an employee aged 55 or over draws their pension early as a result of exiting; and
- Proposals to require high earners to repay severance payments if they secure re-employment in the public sector within 12 months.
The proposals to require high earners to repay exit payments if they return to the public sector have previously been consulted on but there has been no further indication of if and when this proposal will be implemented. Therefore, the two most important issues currently are the implementation of the £95,000 exit payment cap and the proposed reform of the DCPR and LGPS.
£95,000 cap on exit payments
In 2015 the Government first announced plans to introduce a cap on exit payments in the public sector. The cap applies to the total amount payable when someone exits and so applies to the total of severance payments, any pension strain cost and notice payments in excess of three months. The cap, set at £95,000, was legislated for in the Enterprise Act 2016, which amends the Small Business, Enterprise and Employment Act 2015, but required secondary legislation to be introduced.
On 21 July 2020, HM Treasury laid the implementing regulations in Parliament. These were approved by the House of Lords on 23 September 2020 and the House of Commons on 30 September 2020. They were officially made on 14 October 2020 and have come into effect from 4 November 2020.
Under the Direction, mandatory relaxations apply where:
- The obligation to make the exit payment arises as a result of the application of TUPE Regulations or the EU Acquired Rights Directive. Please note, this may therefore not apply to TUPE-like transfers resulting from local government re-organisation where employees transfer under legislation other than the TUPE Regulations; or
- The payment relates to a complaint that an employment tribunal has the jurisdiction to consider under the whistleblowing provisions of the Employment Rights Act 1996, the discrimination provisions of the Equality Act 2010, or health and safety related detriment and dismissal claims. This can include payments made under a settlement agreement to settle a grievance or employment tribunal case.
Discretionary relaxations could also apply where the Decision Maker (full council in the case of an English local authority that not exercising the power) would cause undue hardship:
- That not exercising the power would significantly inhibit workforce reform
- That a written agreement to exit was made before the coming into force of the Regulations; and
- It was the intention of both parties that the exit would occur before that date; and
- That any delay to the date of exit was not attributable to the employee or office holder as applicable.
The Guidance sets out more information on the waiver process and provides that where the full council of an English local authority exercises the discretionary power to relax the cap it has to submit a business case to MHCLG for approval by the Principal Accounting Officer (the Permanent Secretary) and the Minister before it is then submitted to HM Treasury for approval. In the case of a mandatory relaxation the authority does not need HM Treasury approval but still needs MHCLG approval. There is a proforma in the Guidance that employers should use to seek approval from HM Treasury, however, there is no guidance as yet from MHCLG on its process.
It is recommended that employers read the Guidance, as it also contains information on:
- Employers in scope;
- What payments are covered; and
- Employer and employee responsibilities.
Exits in progress
To date no guidance has been forthcoming from MHCLG to address the concerns of those employers who are currently conducting a redundancy exercise. Given the restrictions on discretionary relaxation for reasons of timing in the HM Treasury Direction, employers will be seeking legal advice relating to their specific circumstances regarding any exits occurring on or after 4 November 2020 that exceed the cap.
Pension strain payments
Local authority employers are referred to the LGPS Scheme Advisory Board (SAB) commentary on the £95,000 exit payment cap coming into force on 4 November 2020 under the Exit Cap Regulations and the impact on employer’s pension strain payments as a consequence of an unreduced pension being paid by a pension administering authority under the LGPS Regulations for those aged 55 or over.
Employers will see from the note produced by the LGPS Scheme Advisory Board (SAB) that, any pension paid to the employee, including an entitlement to an unreduced pension under Reg 30(7) of the LGPS Regulations is not payable by the employer – instead, it is payable by, and the responsibility of, the LGPS administering authority. The LGPS administering authority can then request a strain payment from the employer, which could be a sum which would result in a breach of the £95,000 cap. Under the Exit Cap Regulations, employers can make a strain payment up to that amount, allowing for the value of other exit payments made to this individual.
To ensure that employees who are not subject to the cap continue to receive an unreduced pension, employers must notify the LGPS administering authority of any employees who are subject to the cap (including strain cost) prior to the exit.
Employers and LGPS administering authorities will need to take their own legal advice on what to do in the period between the Exit Cap Regulations coming into force on 4 November 2020 and the LGPS Regulations being amended early next year to expressly remove the entitlement to an unreduced pension under Reg 30(7) which would result in a breach of the cap. However, subject to any such advice, the SAB opinion which is based on the legal advice it has obtained, is:
“The course of action presenting the least risk to both LGPS administering authorities and scheme employers is for the:
- LGPS administering authority to offer the member the opportunity to take a deferred benefit under LGPS regulation 6 or a fully actuarially reduced pension under LGPS regulation 30(5)
- Scheme employer to delay the payment of a cash alternative under regulation 8 of the Exit Cap Regulations.”
In considering what steps to take key considerations for employers are as follows.
It is for the LGPS administering authority, not the employer, to decide whether to pay an unreduced pension under LGPS Reg 30(7) or a reduced pension under Reg 30(5). Employers should ensure the LGPS administering authority has confirmed what it intends to do, and that the employee understands the position.
In the first instance, the employer is responsible for paying statutory redundancy pay. In terms of any other payments from the employer, however, such as enhanced redundancy pay under its discretionary compensation scheme, employers should take legal advice on the extent of such entitlements and the balance of risk of delaying further payments.
The Exit Cap Regulations provide that a payment in consequence of a court or tribunal order is not subject to the cap. Therefore, should an employee succeed in a claim against an employer to obtain a payment in excess of the cap, the employer would have to pay that sum.
Should an employer go ahead and make a cash alternative payment under Exit Cap Reg 8, it could still face increased employer pension contributions in the longer term. In any event, if an employer chooses to go ahead and pay a cash alternative payment it would be advisable not to make the payment until it is clear what the LGPS administering authority obligations are in regard to payment of pension.
The payment of a cash alternative to an employee will incur Income Tax and employer National Insurance contributions (on the total of all termination payments in excess of £30,000). HM Treasury Guidance (paragraph 4.4) is clear that a cash alternative may be paid to the scheme administrators. Following an unsuccessful challenge, an employee who receives a reduced pension may have preferred the amount to be paid into the LGPS in order to purchase additional pension rather than receiving it as cash. This will not be possible if the cash alternative has already been paid to the employee.
The Government has introduced a cap on the amount of money a public sector employer can pay when an employee leaves their employment. It is called the public sector exit cap, or £95,000 cap. It applies to employees leaving public sector employments from 4 November 2020.
The exit cap is most likely to affect you if you are a public sector employee aged 55 or over and you are made redundant or you leave your employment due to business efficiency. This is because the amount your employer pays to the pension fund so that you can receive your pension early is included in the exit cap calculation.
Why has the exit cap been introduced?
The Government is concerned about the number and the amount of exit payments made to public sector workers. The exit cap, as well as other planned changes, are meant to ensure better use of public money and ensure that workers across the public sector are treated in a similar way.
Will the exit cap apply to me?
If you work for a public sector employer and you leave your employment on or after 4 November 2020, the total exit payment your employer can pay, including the money they pay to the pension fund on your behalf, will be subject to the exit cap.
Public sector employers include councils, schools and academies.
Check with your employer if you are not sure if you work for a public sector employer.
Your employer can apply to the Government for the cap not to apply in some limited circumstances such as genuine hardship.
How much is the exit cap?
£95,000, which sounds like a lot of money, but it will include any amount your employer pays to the pension fund on your behalf. If you are made redundant or leave due to business efficiency, your employer normally pays towards the cost of you receiving your pension early.
What payments are included in the calculation of the exit cap?
The main types of payments that will count in the calculation of the exit cap calculation are:
- Redundancy payments;
- Severance or ex-gratia payments;
- Money paid to the pension fund to allow you to take the pension you have built up without a reduction for early payment; and
- Any other payment paid to you because you have left your employment.
This is not a complete list. Any lump sum paid to you from the pension fund, sometimes referred to as a retirement grant, does not count towards the calculation of the exit cap.
What does this mean for my pension if I am made redundant or leave due to business efficiency and I am aged 55 or over?
If the total of the exit payments your employer pays to you, and to the pension fund on your behalf, is £95,000 or less you will not be affected by the exit cap. You will receive the pension you have built up straight away, without any reductions because it is being paid early.
If the total amount is over £95,000, then the situation is more complicated. This is because the pension scheme rules have not yet been changed for the exit cap, so the two sets of rules clash. The pension scheme rules still say that you are entitled to receive the pension you have built up straight away without any reduction for early payment; however, the exit cap rules do not allow your employer to pay for this if the total cost of your exit is over £95,000.
The Government is planning to change the pension scheme rules for future exits; but if you leave between 4 November 2020 and the date the rules are changed, the Government recommends that you are allowed to either:
- Take your pension straight away but with reductions for early payment, or
- Defer your pension – this means you take it later.
If you defer your pension it will still be reduced if you take it before your normal retirement age or increased if you take it after.
You have a right to appeal any decision your pension fund makes about your pension benefits.
If I am paid a reduced or deferred pension will I be compensated?
The exit cap rules allow your employer to pay you a cash alternative if they are prevented from paying for you to take your pension early without a reduction for early payment. This situation will occur if:
- You are made redundant or leave due to business efficiency;
- You are aged 55 or over;
- The total cost of your exit is over £95,000;
- You work for a public sector employer; or
- You leave between 4 November 2020 and the date the pension scheme rules are changed.
However, your employer is likely to delay paying the cash alternative to you until the clash in exit cap and pension scheme rules, mentioned in the previous question, is resolved.
If you accept payment of a cash alternative and decide to appeal the decision to pay you a reduced or deferred pension, you are likely to be awarded less if you win.
You will pay Income Tax on the total compensation you receive above £30,000. This will include redundancy, severance and cash alternative payments.
I am under age 55 am I likely to be affected?
Most employees will not be affected by the exit cap if they are under age 55 when they are made redundant or leave due to business efficiency.
My pension is being paid early due to my ill health – will I be affected?
No, ill health retirements are not covered by the exit cap.
My employer has agreed for me to flexibly retire – will the exit cap apply?
Not if your flexible retirement is being treated as a change to your existing contract. Check with your employer if you are not sure.
How does the cap work if I am leaving more than one employment?
The £95,000 limit applies to any public sector employments you leave within a 28-day period.
Are any other changes to exit pay planned?
Yes. The Government has recently consulted on a number of changes including:
- Limiting the amount of discretionary compensation, or severance pay, your employer can pay you; and
- Deducting any statutory redundancy pay from the amount your employer can pay to the pension fund on your behalf. If you are aged 55 or over and you are made redundant, or leave due to business efficiency, your employer normally pays towards the cost of you receiving your pension early.
We do not know if the Government will go ahead with these changes – they are only proposals at the moment.