Capital costs of early retirement


Table of Contents

Capital costs of early retirement

Where a scheme member retires early with the immediate entitlement to benefits, there is a cost implication to the pension fund and the employer. The cost of any augmented benefits is obvious but there is also a "hidden" cost to retiring a scheme member prior to normal retirement age.

A report by the Audit Commission in 1998, highlighted the fact that Pension Funds were being penalised for the cost of early retirements. This was due to the fact that benefits would be paid over a longer period of time to a retiring member as well as the effects of lost investments and income (employee and employer contributions). All of this has led to administering authorities being audited and procedures being adopted in order to ensure that pension funds are not disadvantaged by employing authorities policies regarding the early retirement of staff.

A national approach has now been adopted for calculating the capital cost of early retirement. The principal behind the calculation is to apply early retirement factors to the accrued pension and then capitalise the benefits by using augmentation factors in accordance with GAD guidance.

Where an employer grants additional augmented years under Regulation 12 of the LGPS (Benefits, Membership and Contributions) Regulations 2007, there are three elements to the cost:

i. The capital or hidden cost of releasing statutory benefits early;
ii. The augmentation cost of providing additional pension as a result of granting augmented years;
iii. The cost of any additional lump sum awarded as a result of the augmented years being granted.

Administrators should always seek the advice of the administering authority or the pension scheme administrators when determining the capital cost of early retirement.

We have produced a briefing note providing further information on early retirement costs which can be downloaded here.