Are you a public employee and close to retirement age? If you prefer to not ‘separate from service’ quite yet, opting for a DROP retirement program can be worthwhile.
Depending on your employer, DROP is short for “deferred retirement option program” or “deferred retirement option plan.” DROP plans first came about in the 1980s for public-sector employees. Currently, members of law enforcement, firefighters, educators, and other civil employees often have this sort of program as an option for delayed retirement.
You have probably heard of some of the many states that offer a DROP program, including Florida, Ohio, Texas, and California. Of course, state governments aren’t the only ones with DROP programs. Municipal governments also offer DROP retirement options to their employees.
DROP benefits can be a great boon to employees who would otherwise prefer to keep working and not quite settle into retirement. If you do have this option as part of your retirement benefits, it’s a good idea to look more into it and see if it might make sense for your working goals.
Are you unsure about whether your retirement system has a DROP option? You can check with your HR department for more information.
All of that said, here is a quick rundown of what deferred retirement option plans involve and what sort of benefits you might obtain from it as a long-term civil employee.
What Is a Deferred Retirement Option Plan?
Many public-sector employees often have guaranteed pensions to rely on when they retire. They may also be able to contribute to a 403(b) plan or 457(b) plan to bolster their retirement savings.
But these two vehicles, combined, may still not be enough to cover all their expected living expenses when they retire. This is where a DROP account can help fill the gap. These plans can help employees who decide to work past their full retirement age to accumulate more money for their retirement savings.
DROPs are used in lieu of further credits of service to a defined-benefit pension plan for a few years after the employee has worked for a certain period, such as 25 or 30 years. Once this period has been fulfilled, then the DROP kicks in. The employee will be paid a certain amount of money each year into their DROP account.
Some DROPs last for three or four years. Others may run for as long as seven years. During this period, the employee can continue to collect their salary, but their benefits may be cancelled in some cases.
If they are working past their full retirement age (as prescribed by their employer), they may lose their insurance and other benefits and only receive their salary.
This possibility must therefore be taken into consideration before the employee decides to move ahead and keep working.
Who Gets DROP Benefits?
Any public service employee who is eligible to receive a guaranteed pension after they retire is usually eligible to participate in the DROP.
A policeman who has worked for 30 years and then retires is an example of an eligible DROP candidate. But a public employee should have already maxed out their pension benefits, so that any additional years of service won’t be counted in computing their monthly pension benefit.
The exact number of years that an employee must work in order to become eligible for the DROP varies from one public employer to another.
How Are DROP Benefits Calculated?
The exact formula that is used to calculate the DROP benefit differs from one state or employer to another. How much you can receive in DROP benefits depends on benefits calculations tied to:
- Your average annual salary
- How many years of service that you have as a public employee
- The accrual rate for DROP benefits
- How long that you choose to participate in DROP (limits apply)
An example of how the DROP benefit is calculated can be shown with the Florida Retirement System (FRS).
In this system, 30 years of service makes an employee eligible to retire. If they keep working for another few years, then they will be eligible for a DROP.
The crediting formula used by the FRS is: 30 years of service times the average of the 5 or 8 highest fiscal years of earnings times a classification multiplier.
For special risk employees, this multiplier is 3%. For regular risk employees, this multiplier is 1.6%. For Florida Retirement System employees whose DROP date began after July 2011, the accrual rate is 1.3%.
So, a police officer with 30 years of service and a 5 year high average salary of $55,000 would receive an annual payment into the DROP account of $49,500 per year that will earn interest at a rate of 1.3%.
Again, the exact formula used by each public employer will vary by state and other factors. But in most cases, the amount of money that is deposited into the DROP account can be substantial.
What are Your Options with a DROP When You Actually Leave Your Job?
Employees who leave their jobs after accumulating DROP money have a variety of options for how to handle this money:
- Take a lump-sum distribution
- Move the DROP money into the deferred compensation plan of their employer retirement system
- Roll the money over into an IRA
To put this into context, let’s go back to our example with the Florida Retirement System.
Employees in the Florida Retirement System can roll their DROP money into their FRS deferred compensation plan. From there, they can take advantage of the plan’s low-cost investment offerings.
They can also roll their DROP money into an IRA, giving them more financial options for how they will generate sufficient income for their retirement years.
On the other hand, they can take a lump-sum payment of the full amount in the DROP account. But the money will be taxed, and a full distribution in a single year may land the employee in a higher tax bracket.
However, they don’t have the option of simply leaving the DROP where it is. Public employees are required to either withdraw the money or move it to another retirement account.
Most DROP participants would benefit from the aid of a qualified financial professional.
A good candidate for this guidance would be someone who understands your unique benefits as a public employee – and how they fit into your overall picture for retirement.
How Can Taxes Affect Your DROP Benefits in General?
Your financial advisor can show you the possible tax ramifications and penalties that may apply in various scenarios and what you can do to minimize your tax bill.
If you take a lump-sum distribution before you reach age 59.5, then you may be assessed a 10% early withdrawal penalty by the IRS on top of your tax bill. This early withdrawal penalty also applies to retirement account withdrawals made before 59.5, in general.
What if you still have questions about taxes on your withdrawals or what your options are once you stop working? Your DROP plan custodian can help you with addressing these what-ifs and exploring your choices.
An experienced financial professional can also help you weigh the pros and cons of different scenarios once you know your options.
Still Not Enough?
A DROP program provides a great opportunity for building up additional retirement savings before you separate from service. Nonetheless, you may still not have enough guaranteed income coming in every month to meet your monthly expenses.
Your house may still not be paid off or you may be helping your kids get through college. Fortunately, there are ways to increase your guaranteed income without having to rely on your employer or the government.
Annuities are ideal retirement vehicles for those who want to receive a guaranteed income that they can’t outlive. They can provide many other benefits as well.
If you have participated in your employer’s 403(b) plan or 457(b) plan on top of your other forms of savings, then you may want to consider an annuity as part of your financial mix. Besides Social Security, they are the only financial vehicle that can pay you a guaranteed income for as long as you may live.
There are several different types of annuities available today that can provide growth or income, depending on what you are looking for.
Some Final Thoughts
DROPs can be an important additional source of retirement savings for public employees. If you aren’t quite ready for your post-career years yet, it can be a good bridge for continuing to work while building up your nest egg.
This can give you more time for your retirement money to compound. What’s more, waiting to take withdrawals in later years also shortens the timeline for which you would have to plan for retirement income.
Consult with your employer or financial advisor for more information on DROPs and how they work. They may just make a real difference in the life you can lead after you retire.
Planning for Your Retirement Benefits
Public employees have different needs for retirement planning than folks in private-sector employment. Their defined-benefit plan provides them with a guaranteed income. But, still, it can be hard to navigate all the ins, outs, and what-ifs of other benefits such as a DROP program.
Are you looking for someone to guide you and help you explore your choices for your financial future? If so, for your convenience, many independent financial professionals are available to assist you at SafeMoney.com.
Use our “Find a Financial Professional” section to find someone and connect with them directly. You can request an initial appointment to discuss your situation, questions, and explore a working relationship. Should you want a personal referral for your needs, please feel free to call us at 877.476.9723.