What will the new public sector exit payments cap mean for employers?

Caroline Yarrow and Alex Rush explain whether the changes will lead to a taxpayer saving – or a runway to the employment tribunal

The Restriction of Public Sector Exit Payments Regulations 2020 came into force on 4 November 2020. The regulations have a considerable impact on public sector exit arrangements for those public bodies listed in the schedule to the regulations.

The legislation stems from an initiative in 2015, where the then government sought to reduce the cost of public sector redundancy payments to the taxpayer. 

In summary: 

  • The regulations introduce a £95,000 cap on the aggregate value (before tax) of exit payments made to public sector employees, including redundancy and voluntary exit payments. 
  • The scope of the cap extends beyond direct payments – it also catches actuarial strain costs paid by an employer to a pension scheme to facilitate early retirement pensions on an unreduced basis (payable from many public sector pension schemes on redundancy above a specified age).
  • Certain exit payments are excluded from the cap including injury compensation, payment in lieu of accrued but untaken holiday, payment in lieu of notice not exceeding 25 per cent of annual salary and payments under a court order.
  • The cap does not apply in ‘mandatory’ situations (including where TUPE rights would be affected or to settle certain, but not all, employment tribunal litigation). 
  • In exceptional cases, the employer has a discretionary power to relax the cap subject to various approvals. 
  • The regulations override employment contract obligations. 
  • The terms of public sector pension schemes are being amended to limit early retirement enhancements that might otherwise result in the cap being breached.

While the cap may result in substantial savings to those employers that are covered by the regulations and the public purse more generally, its effect and the manner of its implementation creates several employment and pensions’ law issues. 

First, the cap does not just affect top-level managers. Long-serving employees with modest salaries could find that an indirect ‘strain’ payment to fund an unreduced early retirement pension uses up most of the cap. This may make redundancy exercises more complex and reduce the uptake of voluntary redundancy packages, particularly by older employees. Employers will need to consider carefully the structuring of any exit arrangement and may need to seek input from each affected employee to find the right individual exit solution.

Second, the regulations take effect before the pension schemes have been amended to accommodate the cap. This may create a short-term situation where a breach of law will occur – the scheme rules may require a payment that exceeds the cap, resulting in a choice between breaching the regulations or the statutory provisions of the pension scheme. This, together with the cap’s effect on pre-existing rights under an employee’s employment contract and commitments made by earlier governments not to meddle in public sector pensions (for example, a 25-year promise made in 2013), could result in legal challenges from individuals, groups of employees and/or unions. 

Third, the cap does not apply where a member of a public sector pension scheme is in private sector employment. This means that employees carrying out public functions in the context of outsourcing might be better off on redundancy than their counterparts, who are made redundant from public sector employment. This anomaly is compounded by the fact that so-called ‘Beckmann rights’ on a TUPE transfer are protected from the cap. This means that outsourced staff who transfer back to public sector employment – for example, at the end of an outsourcing agreement where a previously outsourced function is brought back under public sector control – could retain their valuable early retirement pension rights.

Fourth, the cap might inadvertently result in a situation whereby employees who are potentially to be exited seek to craft a narrative about potential claims to manoeuvre themselves within the exceptions to the cap and discussions about exit could become more costly and time-consuming as a result.

Given the issues and anomalies set out above, it remains to be seen whether the cap will deliver the long-term taxpayer savings it is targeting.

Caroline Yarrow is a partner in the employment team, and Alex Rush is legal director in the pensions team, at BDB Pitmans