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Texas Performance Review
Disturbing the Peace
Chapter 7
Employee Issues
EI 6: Adopt an Early Retirement Incentive for State Employees

The state should adopt a new early retirement incentive plan for its employees.

Background

Public and private employers offer early retirement incentives to encourage employees to retire sooner than they had planned. Early retirement incentives are temporary increases in retirement benefits that are offered for a limited period known as a retirement "window." The incentives can benefit employers by reducing payroll costs, creating a smaller workforce, and providing an opportunity to reorganize staff or reduce the number of higher-paid middle managers.

Early retirement incentives vary in form, but some of the most common ones change components of the standard retirement formula used in defined benefit plans (see definition below). Some examples include increasing the benefit rate or changing the calculation of final salary, reducing the age or years of service required for retirement, and adding years to a person's age or service when determining retirement eligibility. Effective incentives that do not change the benefit formula include: eliminating penalties for early retirement, paying health or life insurance premiums, and paying lump-sum retirement bonuses.[1]

The Employees Retirement System of Texas (ERS) administers a defined-benefit pension plan for state employees. Under this plan, the state pays retirees a normal retirement annuity based on a benefit formula that uses an employee's years of service, a benefit rate of 2 percent for each year of service and the final average salary. Thus, an employee who retires with 25 years of service would receive a monthly annuity of 50 percent (25 years of service multiplied by 2 percent) of the final average monthly salary, which is the average of the highest 36 months of earnings.

ERS members are eligible for normal retirement at age 60 with five years of service (without health insurance eligibility), age 60 with ten years of service (with health insurance eligibility), age 55 with 25 years of service, or age 50 with 30 years of service. ERS members who are commissioned peace officers and custodial officers are eligible for normal retirement at age 50 with 20 years of service or age 55 with 10 years of service. ERS does not give members the option of retiring early with reduced benefits.[2]

Past incentives

Since 1986, the Texas Legislature has adopted two retirement incentives for ERS members. In 1986, the Legislature passed House Bill 40 to reduce the state workforce without layoffs. In 1993, based on a recommendation in TPR's Against the Grain report, the Legislature passed Senate Bill 81 to reduce state employee payroll costs and reorganize state agencies.[3]

House Bill 40 allowed eligible ERS members to retire between November 30, 1986, and May 31, 1987, with a benefit rate of 2 percent for all years of service. At that time, the benefit rate was 1.5 percent for the first ten years of service and 2 percent for subsequent years. The higher benefit rate increased benefits 6.7 percent for members with 40 years of service and 33.3 percent for members with ten years of service.[4]

About 2,198 employees, or 43 percent of eligible members, with total annual salaries of $75.6 million retired during the window. Although the incentive increased ERS' unfunded actuarial liability by $186.2 million, and the amortization period by 8.5 years, it did not require an increase in the state contribution rate to ERS.[5]

While House Bill 40 probably produced payroll savings, salary savings were not monitored and agency budget cuts were not required. Originally, the bill stipulated that retiring employees could not return to work for the state; however, before the window closed, the Legislature allowed employees who retired during that period to return to full- or part-time state employment.

The second retirement incentive--Senate Bill 81--allowed members eligible for retirement between September 1, 1993, and August 31, 1995, to retire with a benefit rate of 2.25 percent for each year of service--a 12.5 percent increase in the normal retirement benefit rate of 2 percent for each year of service. To receive the increased benefits, eligible employees had to retire on September 30, 1993, or the earliest date they were eligible to retire during the 1994-95 biennium.

The legislation required the Legislative Budget Board to reduce general revenue appropriations by at least $13.4 million by November 1, 1993 and an additional $27.3 million by November 1, 1994.[6]

By August 31, 1995, 5,938 state employees--65 percent of those eligible--with an estimated $194 million in total annual salaries at the time of retirement had retired under Senate Bill 81.[7]

Exhibit 1 depicts the distribution of Senate Bill 81 retirements and average retiree salaries for the top 25 agencies. While precise figures on the number of managers retiring under Senate Bill 81 are not available, the higher-than-average salaries shown in Exhibit 1 indicate that many of the retirees held management positions.

Exhibit 1

Senate Bill 81 Retirements

As of August 31, 1995

Texas State AgencyNumber of RetireesCombined Annual SalariesAnnual Retiree Salary
Department of Transportation1,690$ 58,792,544 $34,788
Department of Mental Health-Mental Retardation1,058 25,276,48423,891
Department of Public Safety41114,264,41834,707
Department of Criminal Justice-Institutional Division386 12,162,21231,508
Department of Human Services36311,063,584 30,478
Department of Health35311,111,45231,477
Employment Commission33811,818,012 34,965
Parks and Wildlife Department1635,603,57834,378
Rehabilitation Commission1264,882,924 38,753
Education Agency1225,060,76241,482
Department of Protective and Regulatory Services962,958,24430,815
Comptroller of Public Accounts893,662,306 41,150
Natural Resource Conservation Commission793,393,474 42,955
Department of Insurance622,474,95439,919
Alcoholic Beverage Commission602,310,39638,507
Youth Commission541,591,50029,472
Railroad Commission491,939,83239,588
General Services Commission461,224,28626,615
Department of Agriculture31996,02032,130
Office of Attorney General291,267,75243,716
Adjutant General24738,06430,753
Water Development Board18790,52043,918
General Land Office17730,51042,971
House of Representatives17383,64022,567
Animal Health Commission15421,83628,122
Other2428,720,86036,037
Total 5,938 $193,640,164 $32,610

Source: Employees Retirement System of Texas.

Senate Bill 81 did not prohibit rehiring the new retirees or prevent retirees from providing services to the state as independent contractors.

Exhibit 2 summarizes the number of retirees who were rehired by the same agency. Some agencies, such as the Comptroller's office, did not permit rehiring early retirees. By August 31, 1995, 690 of the nearly 6,000 new retirees had been rehired by the state during the biennium. Of those rehired, 448 were working at the same state agency from which they had retired.[8]

Exhibit 2

Rehires--Top 10 Agencies

As of August 31, 1995

Texas State AgencyNumber of RehiresCombined Annual SalariesAverage Annual Rehire Salary
Department of Mental Health and Mental Retardation167$ 4,688,939$28,077
Parks and Wildlife Department491,482,70730,259
Department of Criminal Justice391,105,66928,350
Employment Commission371,006,26827,196
Department of Health321,031,31332,229
Rehabilitation Commission20686,13634,307
Department of Protective and Regulatory Services19487,35525,650
Water Development Board8262,89032,861
Commission for the Blind6190,77631,796
Youth Commission6255,56542,594
Other651,875,54928,855
Total448$13,073,167$29,181

Source: Human Resources Information Services, Texas Comptroller of Public Accounts.

Current law allows ERS retirees (other than judges and elected officials) to return to work for the state for up to nine months in a fiscal year before the state suspends the employee's retirement annuity. If the employee works more than nine months, ERS suspends the annuity until the next fiscal year or until the retiree leaves state employment, whichever comes first.[9] The retirement benefits of a retiree who serves the state as an independent contractor are not affected.[10]

The 1991 Legislature increased the period that retirees were allowed to work from six to nine months, thereby permitting retirees who return to work temporarily--for special projects and seasonal employment--to receive both a salary and a retirement annuity from the state. When a retiree returns to state employment, however, the state does not contribute to the retiree's existing retirement account.[11]

Public versus private

According to a Texas State Pension Review Board 1994 survey, early retirement windows are common in the public sector. The board received survey responses from 56 pension funds; of those, 36 had adopted early retirement incentives within the last five years. The most common incentives expanded retirement eligibility by granting additional credit for age/service or reducing age/service requirements. Overall, the survey results indicated that 30 to 40 percent of eligible employees took advantage of the incentives. The more generous incentives had higher employee participation rates.[12]

Early retirement incentives also are used in the private sector. A Wyatt Company survey of the country's 50 largest corporations found that 38 had offered at least one early retirement window in the last ten years.[13] On average, 49 percent of eligible employees chose early retirement.

Recommendations

A. State law should be amended to create an early retirement incentive window for the 1998-99 biennium. When determining eligibility for retirement, state employees should receive additional credit of five years of age.

The early retirement incentive should apply only to Employees Retirement System (ERS) employee-class members (excluding judges and elected officials). To retire early, beginning September 1, 1997, employees must retire on the first date they become eligible. For example, all employees eligible to retire September 1, 1997, with the additional age credit must retire September 30, 1997, to receive the early benefits. (ERS retirements occur on the last day of the month.) Otherwise, they must wait to retire under normal retirement provisions.

The recommendation would allow more state employees to become eligible for retirement during the 1998-1999 biennium but would not increase retirement benefits. State agency budgets would be reduced by the annual salary of each employee retiring early during the window and by the state's retirement and social security contributions. This recommendation would not require an increase in the ERS retirement contribution rate.

The early retirement incentive would decrease the actuarial liability of the ERS retirement fund and produce a payroll savings for the state. The recommendation would reduce the state's average payroll cost by reducing the number of older, higher-paid employees.

B. State agency appropriations should be reduced by the amount of the final annual salary and the state's contribution for retirement and social security for each employee retiring early during the two-year window.

To accomplish the budget reduction, ERS should report to the Comptroller's office the final annual salary for each employee who retires early under the incentive. The Comptroller's office should be directed to reduce state agency appropriations by the amount of the final annual salary and the state's contribution for retirement and social security when each employee retires during the window. The budget reduction should be based on the number of months remaining in the biennium after each retirement. Exemptions should be made for small agencies, such as those with annual appropriations of less than $1 million. The Legislature should identify other types of exemptions, if appropriate.

C. State law should be amended to prohibit ERS employee-class retirees who return to work for the state as employees or contractors from receiving a retirement annuity while working for the state. The retirement annuity should be suspended by ERS until the retiree no longer holds a position as a state employee or serves as a contractor.

TPR found no compelling reason to allow retirees to receive both a salary and a retirement annuity from the state for up to nine months each fiscal year.

D. State law should be amended to bar regular retirees and incentive retirees from contracting with the state to provide services as independent contractors (including consulting, professional, and all other contracted services) for 12 months after their effective retirement date.

The 1995 General Appropriations Act prohibits state agencies from entering into consultant contracts--those contracts defined as "consulting services" under Section 2254.021, Government Code, Title 10--with a person who was previously employed by the agency in the last 12 months.[14] This provision, however, does not prohibit agencies from contracting with previous employees for other types of services excluded from the definition of consultant services, such as professional services provided by accountants, architects, engineers, and others defined under Section 2254.002, Government Code, Title 10.

Fiscal Impact

ERS member records as of August 1995 show that 10,777 employees would become eligible for early retirement during the 1998-99 biennium as a result of adding five years to their age. Of this number, 9,434 employees would be eligible to retire on September 30, 1997, and the remaining 1,343 employees would become eligible to retire at various times during the 1998-99 biennium. The eligible employees have a total annual payroll of $321 million, and an average annual salary of $29,761.

According to Leggette Company, the actuarial impact of the recommendation would be minimal.[15] The recommendation would decrease the actuarial liabilities of the ERS retirement fund as a result of employees accruing fewer benefits in future years due to early retirement. The increased costs associated with the earlier start date for benefits and the longer payout period is offset by the lower projected pension benefit.[16]

For example, under the proposed early retirement incentive, a 50-year-old employee with 25 years of service could retire early with an annuity of 50 percent of salary (25 years of service multiplied by 2 percent). Under normal retirement provisions, this same employee would be required to work another five years to become eligible for retirement at age 55 with 30 years of service. Upon retirement at age 55, the employee would receive an annuity of 60 percent of salary as a result of the additional five years of service credit earned--rather than a 50-percent annuity under the early retirement window.

The recommendation also would have an actuarial impact on the Teacher Retirement System (TRS) because state employees currently are allowed to transfer service credit between TRS and ERS upon retirement. Service credit is transferred at the time of retirement to the system from which the member retires.[17] This recommendation would require TRS to pay ERS for transferred service credit sooner than normal. The actuarial impact to TRS as a result of this provision cannot be estimated at this time, and should be determined by TRS' actuary if legislation is introduced.

The recommendation also would have an actuarial impact on the Law Enforcement and Custodial Officer Supplemental Retirement Fund as a result of employees retiring under the window sooner than normal. This actuarial impact cannot be estimated at this time, however, and should be determined by ERS' actuary if legislation is introduced.

The recommendation to suspend annuity payments for retirees who return to work for the state would have a positive actuarial impact on the ERS retirement fund. This impact also should be determined by ERS' actuary if legislation is introduced.

Payroll savings would be reduced from agency appropriations during the 1998-99 biennium, and it is assumed that none of those vacated positions would be filled. The estimated cost of lump-sum termination payments assumes an average annual leave balance per retiree of 319 hours, which was the average leave balance of employees retiring from the Comptroller's office through August 1995. Assuming 5 percent of eligible employees retire under the window, 472 employees with total annual payroll of $14.2 million would be expected to retire in fiscal 1998, and another 67 employees with a payroll of $1.9 million in fiscal 1999.

The fiscal impact of the recommendation is summarized below:

Fiscal YearLump-Sum
Payroll Savings
Termination Payments
1998$13,789,000$(1,832,000)
199917,155,000260,000
200018,227,0000
200118,227,0000
200218,227,0000

Fiscal YearSavings to the
General Revenue Fund
Savings to Other Funds
1998$6,283,000$5,674,000
19998,878,0008,017,000
20009,578,0008,649,000
20019,578,0008,649,000
20029,578,0008,649,000

Fiscal YearNet Savings
To All Funds
Change in FTEs
1998$11,957,000-472.0
199916,895,000-539.0
200018,227,000-539.0
200118,227,000-539.0
200218,227,000-539.0


Footnotes

[1] National Conference of State Legislatures, Fiscal Affairs Program, "National Association of State Budget Officers Reports on States' Experience with Early Retirement," The Fiscal Letter (March/April 1992), p. 4.

[2] Employees Retirement System of Texas, Actuarial Valuation Report, August 31, 1995 by Towers Perrin (Austin, Texas, November 11, 1995), Appendix A.

[3] The 74th Legislature passed Senate Bill 1231, which addressed several state employee retirement issues, including increasing retirement annuities by 12.5 percent for individuals retiring before September 1, 1995. The bill specifically excluded retirees who took advantage of Senate Bill 81 incentives.

[4] Texas State Pension Review Board, "Early Retirement Study Outline," Austin, Texas, 1988, pp. 63-64.

[5] Texas State Pension Review Board, "Early Retirement Study Outline," p. 65.

[6] Texas Comptroller of Public Accounts, Legislative Wrap-up: 73rd Legislature (Austin, Texas, July 1993), p. 219.

[7] Employees Retirement System of Texas, "Incentive Retirees for FY 94 and FY 95," Austin, Texas, September 27, 1996. (Computer printout.)

[8] Texas Comptroller of Public Accounts, "Total and Average Number of Rehired Retired State Employees," Austin, Texas, July 1996. (Computer printout.)

[9] V.T.C.A., Government Code SS812.203(c).

[10] V.T.C.A., Government Code SS812.202(a)(2).

[11] V.T.C.A., Government Code SS812.201(b).

[12] Texas State Pension Review Board, Early Retirement Incentive Programs of Public Pension Plans (Austin, Texas, January 1994), pp. 3-4.

[13] The Wyatt Company, Top 50: A Survey of Retiree Benefits Provided by Plans Covering Salaried Employees of 50 Large U.S. Companies as of January 1, 1994 (Washington, D.C., 1994), pp. 13-14, 70-73.

[14] Texas H.B. 1, 74th Leg., Reg. Sess. (1995), Article IX, SS47.

[15] Leggette & Company, Inc., Final Report to the Comptroller's Office, (Dallas, Texas, September 11, 1996). (Consultant's report.)

[16] Letter from Steve Kennedy, Leggette & Company, Inc., September 11, 1996.

[17] Teacher Retirement System of Texas, "Teacher Retirement in Texas," Austin, Texas, October 1995, p. 21. (Pamphlet.)


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