The Myths and Facts Revolving Around Early Retirement Incentives

September 2010Alerts Education Alert

In this era of limited financial ability on the part of educational institutions to fund their budgets, employee groups and/or unions frequently suggest early retirement incentive programs (ERIPs) as vehicles to save the school entity dollars.

Indeed, the initial logic is simple. If Employee A retires at an annual salary of $100,000.00 per year and is replaced by an employee with a $50,000.00 annual salary, the school entity will, on its face, save $50,000.00.

However, in order to actually measure a savings, an effective ERIP will induce an individual to retire who otherwise was not planning to retire in that year in question. If there is an inducement (usually in the form of actual dollars or retiree healthcare benefits for a defined period of time), those costs need to be subtracted from the savings.

The great unknown about ERIPs is what basis an employer can assert a savings takes place when the employer really does not know if the employee was going to retire anyway either in the first year of the ERIP or some year down the road. This becomes a pure “guestimate” on the part of the employer and no one can absolutely know for sure what was the primary motivating factor in securing an employee’s resignation.

If a unionized entity represents the employees who are subject to the ERIP, in many states, including Pennsylvania, the employers must bargain with the union the implementation and provisions of an ERIP.

A carefully drawn ERIP should address the following issues:

  • Clear eligibility criteria of the employees.
  • Amount of benefit to be received by the employee. It is important to note that if the employer gives the employee options to select for the ERIP it could run afoul of the constructive receipt rules under the Internal Revenue Code. An attorney who is skilled in understanding benefits and tax-related issues needs to review the ERIP to make certain that a constructive receipt issue is not there, which could cause an adverse tax consequence on the employee.
  • The ERIP can establish a minimum number of individuals who need to provide their irrevocable retirement notice to the employer before a date certain in order for the ERIP benefit to be triggered.
  • The ERIP should establish a window period for exercising the rights of the ERIP and the submission of the irrevocable resignation.
    If it does cover retiree healthcare, the ERIP should address what happens if the early retiree’s spouse still remains employed by the school entity or what would happen in the event that the early retiree were to die before all of the benefits under the ERIP were paid out. Some of the issues may be determined by Internal Revenue Code requirements, including but not limited to the ability of an early retiree to have his/her estate collect on such dollars if the monies are to go into a non-elective 403(b) plan upon retirement (this will be a problem).
  • Multiple year payouts for early retirement payments may need to be booked as a liability for the school entity under various GASB requirements. Though ERIPs very often do save school entities money, it is usually not as large as that asserted by the union and the amount of the savings dissipates year after year.
  • Prior to an ERIP being suggested, the demographics of the employees must be reviewed and further reviewed in accordance with either a state-administered pension program or a privately-administered pension program. In many situations, particularly when a state program is involved, an ERIP cannot be successfully fashioned because the employees have too great of an incentive to wait for the statutory pension plan benefits. If a school entity has a very young employee population/bargaining unit, all the retirement incentives in the world will not encourage enough individuals to retire to make the plan worthwhile.
  • There are a number of downsides other than the economics of the situation. A school entity can find itself in a very difficult situation as the result of losing its top educational talent to an ERIP. These are often the educational leaders in the school, which would include but not be limited to department chairs, organizers of various programs in buildings, and the like.
  • Though an ERIP can indeed be used to save a school employer dollars, more often than not, they do not generate enough savings to make them worthwhile.
  • Though the tool of an ERIP should not be overlooked in the negotiations process, they have certainly lost their vogue and are not necessarily popular with the person authoring this blog because of the difficulty in actually calculating the savings from such an ERIP.

If you have any questions about the information contained in this Alert, please contact Jeffrey T. Sultanik or any member of Fox Rothschild’s Education Law Practice.