The Use of Early Retirement Incentives

Type: 
Advisory
Advisory: 

GFOA Advisories identify specific policies and procedures necessary to minimize a government’s exposure to potential loss in connection with its financial management activities. It is not to be interpreted as GFOA sanctioning the underlying activity that gives rise to the exposure.

Background: 

Governments occasionally offer early retirement incentives (ERIs)1 to employees as a strategy to reduce payroll costs or stimulate short-term turnover among staff. ERIs are temporary, usually offered during a window that covers a specific period of time. They can increase the economic value of the standard retirement benefit, be a one-time payment that does not impact an ongoing defined benefit or defined contribution retirement benefit or provide other financial incentives to facilitate retirement before an employee’s otherwise planned retirement.

Recommendation: 

GFOA recommends state and local governments do not use ERIs,2 for the following reasons:

  1. Governments can underestimate the full costs of ERIs. A cost-benefits analysis may not look at the complete array of direct and indirect impacts (i.e., the cost of hiring and training new workers; the cost of independent contractors to fill in during vacancy periods; the cost of additional retiree health care for employees who accepted the ERI; the cost of accrued leave cash outs; and unanticipated effects on public services). Additionally, governments, as employers, may experience increased long-term costs to the retirement system because employees who accept the ERI begin drawing their retirement benefits earlier than expected.
  2. The projected savings of ERIs can be lower than projected. ERIs often assume savings based on replacing long-term, highly-compensated staff with new, lower-paid staff. While the short-term impact of this may be positive, newly-hired staff tend to experience faster salary increases than longer-term employees, making cost savings more short-term in nature. In addition, market factors may require higher than anticipated salaries or benefits to recruit qualified replacements.
  3. ERIs are complex tools that require appropriate cost-benefits analysis, budgetary analysis, legal analysis, and actuarial analysis to determine their impacts. Additionally, it requires extensive implementation effort to communicate the offering to staff, handle the administration of the incentive, and monitor the actual impacts they have on the organization. Analysis of ERIs often focus on the short-term savings and not the long-term impact to an organization, such as the impact upon service delivery after employees retire and loss of institutional knowledge. Disruption to services during the transition can also be greater than anticipated depending on the positions being vacated.
  4. Actual participation in ERI offerings might be lower or higher than expected. As a result, the government might not see the expected cost savings, pay greater than anticipated incentives, or experience a greater service impact than anticipated. Additionally, agencies with low initial participation may issue a subsequent ERI offering, which can distort normal retirement patterns.
Notes: 

1 The scope of this advisory does not cover deferred retirement option plans (DROP) or partial lump-sum option plans (PLOP).

2 See GFOA’s Early Retirement Incentive Risk Analysis Resource.

Approved by GFOA's Executive Board: 
September 2019