October 2022

Understanding How Pensioners Are Paid Through Payroll

By Tim Kelsey, MCIPP, AIPA

While many people believe that age is only a state of mind, we all want to retire at some point in our lives. Hopefully, the reward for a lifetime of hard work is an ongoing income from a pension. That might mean our relationship with the payroll department will be ongoing if that pension was one your company funded. Where an employer has created a sponsored occupational pension plan, key administrative tasks such as paying the pension may remain in house. So, just how different is it to pay a pensioner payroll?


The Definition of a Pensioner

A pensioner on that payroll won’t necessarily be a retired employee, as many plans make provisions for survivor and dependent pensions should the retired employee pre-decease their loved ones. Often, these additional people will need to be regularly reviewed. The pension may also cease upon re-marriage, or the child pensions may continue into adulthood if the recipient is in full-time education. I can recall two brothers in their mid-30s on my former employer’s pensioner payroll because they continued to sign up for further college courses in medicine and dentistry.

By its very nature, the usual way of becoming a leaver on a pensioner payroll is to pass away. At that point, the pension will cease to be due. Unlike work, no one is keeping a regular eye on the pensioner, and therefore a regular payroll activity is the issue of life certificates. These take the form of a letter requiring the recipient to return a tear-off slip confirming—with an actual ink  signature—that they are still alive and well. The life certificate can be used to monitor other disqualification situations such as re-marriage or ceasing full-time education.

The task of dispatch and monitoring replies often also falls to payroll to undertake. In the same vein, it is also important to train staff to watch for signs that a pensioner might have passed away. Signs this has occurred include the return of correspondence, such as pay stubs (although many pensioner payrolls only dispatch pay stubs once a year when the pension payment is increased) and payments being returned by the recipient bank because the account has been closed.

Pension Pay Cycle

Pensioners are often paid in a different pay cycle to the one when they were an employee. The most troublesome is where pensions are paid monthly in advance rather than in arrears as most salaries are paid. The logic for adopting such a cycle is that you can’t spend your pension once you have passed away. So, in the month that a pensioner retires, they would receive two payments—a final salary and an initial pension payment. This can have significant consequences for their tax computation. In effect, on a monthly cycle, they will receive 13 payments in total for the year. This could see them pushed up a tax bracket since they have no tax allowance to offset against the 13th month payment or other pay-related issues, such as inflating total pay for garnishment order calculations. There is no solution to this issue. It is a consequence of the decision to award pensions as an advance payment. It is prudent to prepare communications explaining this to potential pensioners inquiring about their calculation.

When running a pensioner payroll, overpayments are a fact of life and a given if the pension is paid in advance. Even if paid in arrears, notifications of a death can take several months to reach the payroll department. The pension plan will usually have a written policy covering overpayments. The plan will recover any overpayment from the estate of the deceased but may operate a de minimis limit (typically €100, $100, or £100) where the cost of pursuing recovery would exceed the amount recovered. Because of the time it takes to deal with an estate, there is likely to be a significant delay between identification and resolution of a pensioner overpayment. Therefore, it is important to have robust monitoring controls in place to ensure an overpayment is not “forgotten.”


Pensioner Tax

Pensioners will remain taxpayers, but the tax that they pay could radically change. Tax allowances and reliefs claimed as an employee, and reflected in tax cards or codes, may include amounts relating to professional expenses incurred during employment, which are no longer valid. Reminding new pensioners to review their tax position as part of their onboarding as a pensioner is a practical measure that can offer a smooth path from work to retirement. In many jurisdictions, it will be necessary to set a special flag on the record to ensure that correct “pensioner” tax is calculated. For example, in Sweden, tax tables have up to five different options to cover the taxation of a pensioner based on the nature of the pension, age, and whether the pensioner continues to work as well as receiving the pension.

Early retirement is not as widely used today as a tool to manage the workforce, but may still be an option in some countries and companies. This might create a special type of pensioner record such as the Belgian De Cava system. The government in Belgium wished to discourage the practice of using early retirement to ease people out of the workforce. Under the De Cava system, the former employer is obliged to pay, on a decreasing sliding scale, a special employer social insurance contribution on early retirees. This starts at a whopping 142.5% for those under age 55, down to 31.25% on those over age 62, and charged on pensions up to €1,845 per month. This makes early retirement an expensive option for Belgian employers.

Most pensions will be funded by a payment made from a separate pension fund, which the employer would process through a control account—the payment out to pensioners balancing to the funding payment from the pension plan. But you may encounter different arrangements.

Consider the Direktzusage, or Direct Commitment arrangements, in Germany. This style of pension involves the company making a provision for the pension on their balance sheet, a style of pension arrangement which is typically used for senior executives. The balance sheet liability must be insured for insolvency risk but is not a separate pot of money held in a fund. Once the pension starts in payment, it can be outsourced to a pension plan or provident fund by the company purchasing an annuity for the life of the recipient, or the company pays it direct and draws it from the balance sheet commitment. Naturally, the payroll accounting postings therefore need to reflect this.

Be prepared to chat when pensioners call with payroll queries. You may be the only person they get to speak to that day, and they may also have something interesting to tell you about how it used to be at the company.             

Tim Kelsey, MCIPP, AIPA, is Owner of Kelsey’s Payroll Services and has worked in the payroll industry for 33 years, working as a payroll manager for large U.K. public sector bodies paying up to 18,000 employees. His specialty is international payroll. He has run payrolls from Kingston, Jamaica to Entebbe, Uganda, and most places in between. In 2007, he formed his own company, and now spends much of his time writing and lecturing on all aspects of payroll. Kelsey has been a presenter for the American Payroll Association (APA) and Global Payroll Management Institute (GPMI) as well as a guest speaker on APA/GPMI’s podcast, “PayTalk.”
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