Since potential legislative cuts to your retirement benefits are nearly inevitable, we thought it might be educational to discuss your Florida Retirement System Options, and what changes might be made. More importantly, we want you to understand how they might affect you! We will begin this week with the scoop on the Deferred Retirement Option Program (DROP). (For an overview of the DROP program, please see FRSOptions.com)
Back in 1998, when the Deferred Retirement Option Program was initiated by the Florida Retirement System, the world was a different place! The Stock Market was on a roll; having just completed a 10 year run that averaged 19.21% per year. The 5 year Treasury bond was paying about 5.25% and the coffers of the Florida Treasury were flush. Skip ahead to the beginning of 2010 and the stock market has just completed its worst 10 year stint in history, and has a net minus 2% return over the last 10 years. The 5 year treasury is only yielding 2.5%, and the Florida Treasury is facing a revenue shortfall of some $3 billion. A shortfall that is growing, and expected to get even more dire in the foreseeable future.
The Florida Legislature is faced with the daunting task of cutting the budget to meet the shortfall in tax revenues due to the monster recession, and the Florida Retirement System is facing its first year of underfunding in over a decade. The”Sunshine Review” of the State Budget has a succinct outline of the budget situation. Suffice it to say the politicians see employee pension plans as a cherry ripe to be picked. By focusing attention on the temporary underfunding of the FRS pension plan, it seems to have made your retirement benefits an easy target for spending cuts to help balance the state budget. Despite the fact that FRS is one of the most solid Pension funds in the US. You can expect that the legislature will be looking harder and deeper next year, and will most certainly put your retirement benefits at greater risk.
By now we all know of the myriad of bills introduced by the Senate and House, and how broad the scope of changes were. Ultimately, the only real change for the year was a cut in the interest rate paid on the DROP from 6.5% to 3% (see the FRSOptions.info article on the cut). While the cut will hurt future participants, it was not a fatal blow. It was also logical. When the DROP was initiated, 6.5% was about 125% of the then 5.25% five year Treasury bond rate. With the yield on the five year T-bond down to 2.5%, the same 125% premium would put the DROP rate at 3%. If you survey other states with DROP plans, you will realize that 3% is a pretty common rate. Some programs pay as much as 4 or 4.5%, NONE as high as 6.5%. The average is just over 3%. Florida is just lowering the rate to a realistic rate. Rest assured, many other states will be following Florida’s example. While 6.5% interest is unheard of in this financial environment and the change to 3% is radical, but reasonable, the process to enact this law was anything but reasonable. Everyone has a right to be angry about the process, and everyone should be on guard for the upcoming legislative session.
Before and after the cut in the DROP rate, there has been a lot of conversation in the press about the costs and merits of the DROP plan. One of the best overviews we have found was in the Philadelphia City Paper in their article “The Billion Dollar Boondoggle, DROP is bleeding us dry.” While it is a complicated article to follow, it points out the obvious. DROP was intended to be cost neutral to the Retirement System, but is not. The actuarial work is complicated, but in layman’s math, it is pretty simple. A participant in the DROP gets paid twice! This “double dipping” is the crux of the problem. As a DROP participant, you collect your full salary, plus the state pays your pension into a DROP account, and pays interest (now only 3%) on top of that. I have tried to re-create the graph from the article below, with the average numbers for a FRS participant over 5 years.
(Assumptions $50,000 per year, special risk, age 50, DROP at 25 years or retire at 30 years.)
________________________With DROP __________ without DROP
Salary $250,000 $250,000
Pension Contribution 0 $ 50,000
Pension paid into DROP $199,266 $ 0
DROP Interest paid $ 15,000_____________$ 0
TOTALS $464,000 $300,000
Originally, DROP was initiated to keep skilled workers on the job longer. Since the state is no longer in a position to “pay up” to retain employees, it may not make sense to have a DROP program at all. It would be wise to follow the summer study to see how it deals with DROP. The same newspaper did a follow up article about how other states are dealing with the problem in their article “Corrupt and Contented.”
Participants have come to rely on, and perhaps feel entitled to DROP as a retirement enhancement. Legislators representing ALL taxpayers will be asking, “Does this justify the expense of the DROP program. There has been a lot of bad press in regard “double dipping” lately. Most of it has been aimed at re-hiring, but more currently the entire DROP is being called into question. It would not be a surprise if the DROP program goes away, particularly for new hires. Several states, like Texas, have already discontinued DROP for new participants. More will surely follow.
Even without DROP, FRS participants have one of the finest retirement plans in the country. We will be exploring how it compares in upcoming posts. As much as we don’t want the plans to change, it is possible some changes are prudent. I urge you all to be prepared for tedious legislative session next year. Your benefits are at risk!