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State Strategies to Manage Budget Shortfalls

Return to State Strategies to Manage Budget Shortfalls

Case Study: Early Retirement Programs in Minnesota and Virginia

The following discussion of things to look out for in the design of early retirement incentives is based on thorough evaluations of programs in two states, Minnesota and Virginia. The Minnesota program was offered to city, county, school district, university and state employees in 1993. The Virginia program was available to a similar range of state and local employees in 1991. Both evaluations offer pointers for the future, as well as explanations of some unexpected problems that emerged as programs were administered.

In both Minnesota and Virginia, auditors found that the early retirement programs brought a net fiscal loss to state government.

• In Minnesota, the increase in pension and insurance costs was about $100 million on a present-value basis for about 3,300 early retirements. This seemed particularly expensive since it appeared to the auditors that 50 percent of those who received augmented early retirement benefits would have retired in 1993 without the incentive (partly because the program included special incentives for employees over age 65 that attracted a very large proportion of such employees to retire).

• In Virginia, the increase in pension costs was about $238 million (present value) to cover the additional retirement benefits for the 3,535 state employees who took early retirement. The costs in Virginia were higher than in Minnesota. The Virginia program was available to younger employees than the Minnesota program, which means that on average benefits will be paid for more years. Unlike the Minnesota program, Virginia included no special incentives for employees over age 65 (whose life expectancy is shorter).

Auditors in both states recommend that early retirement incentives ought to be targeted to programs, departments or agencies that have an immediate need to downsize or reorganize and not made available across state government.

• The Minnesota finding is that downsizing is essential for savings from an early retirement incentive, and those savings are likely to result from budget decisions independent of an incentive program. Therefore, the primary benefit of a retirement incentive program is to ease the removal of employees who would have to be dismissed anyway.
• The Virginia recommendation is that early retirement incentives should be one tool among others available to programs that have to downsize or reduce spending, not a governmentwide policy for its own sake.

Because savings depend on reducing employment, vacancies need to be tracked and replacements controlled in a more sophisticated way than states ordinarily practice.

• In Virginia, the original goal was a net savings of $37.1 million for FY 1992's state budget (without taking any additional payments to the Virginia Retirement System into account). Saving $37.1 million required that no more than 50 percent of the retirees be replaced. However, replacements were not tracked, and no method existed for deciding how to weigh the costs of (1) using salary savings to fill vacant positions other than those created by the early retirement program and (2) re-employing retirees as contractual, part-time or temporary employees--a widespread practice. Although the goal of budgeting $37.1 million less was met, it appears that only part of the savings came from early retirements and that agencies used a variety of sources to live within their reduced budgets.
• In Minnesota, 61 percent of positions vacated remained empty for somewhat less than a year. This was a slightly higher proportion than was needed to cover program costs for state government. However, to cover costs, the positions would have to remain permanently unfilled, and within a year agencies planned to fill many vacancies. Moreover, no data existed on the salary savings that had been used to fill other, existing, vacant positions.

There are unforeseen costs, not all of them monetary.

• Compensation paid to temporary employees.
• Recruitment and training costs for replacement employees.
• Organizational costs as promotions created a ripple effect down through agencies.
• An increase in the number of employee grievances attributed to hiring inexperienced managers.
• An unexpected exodus of experienced, key employees.

The advantages remain:

• With careful design, early retirement incentives can assist in the smooth and economical downsizing of government.
• Incentives help avoid the disadvantages of involuntary dismissals and allow a graceful end to careers in government.
• Incentives make room for new ideas and management practices.
• With targeting, control of replacements and better reporting on vacancies than is the ordinary rule, early retirement incentive programs can save money.

Return to State Strategies to Manage Budget Shortfalls

Written December 1996, posted January 2003, reviewed December 2003
Email statebudget-info@ncsl.org for more information.
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