For those of you that were interested in entering the DROP, you might not want to give up so quickly because of the decrease in interest rates. The rate reduction from 6.5% to 1.3% initiated by the Florida Legislature as of July 1 does not necessarily make the Deferred Retirement Option Program obsolete. Certainly, it lowers the earnings, but, the biggest part of the DROP sum is not interest, but simply your pension payments accruing each month in the DROP account. There seems to be some misunderstanding about these numbers. It appears that those of you choosing to enter the DROP on or after July 1 will earn the lower 1.3% interest rate on your pension payments. If you are already in the DROP, and once you begin the DROP, you will NOT have to make the 3% employee contributions!
Your DROP amount will not decrease by 70%, only the interest earned will. As we discussed on our web page FRSOptions.info , there is no magic to DROP, the bulk of the DROP benefit is simply your own pension being returned to you after the 5 years.
When you enter the DROP, you technically retire and begin to receive your pension. Since you are going to continue to work, instead of the pension checks coming to you each month, those checks are deposited in your “DROP account”, and interest is then added to it. The monthly amount going into your DROP is determined by the same calculation as your pension, which is: Years of service, multiplied by service credit (3% for special risk, or 1.6% for regular members. The result is then multiplied by your Average Final Compensation, which is the 5 years of your highest earnings. For example, you have worked 30 years, and average of your highest five years of compensation (your AFC) is $50,000. Your calculation is 30 times 1.6%, times $50,000, or a pension of 48% of $50,000, or $24,000 per year – so you would receive $2,000 per month into your DROP account. Each year, on July 1, you will receive an annual increase by whatever your Cost of Living Adjustment (COLA) is.
If you are a Florida Retirement System regular risk participant with an average final compensation of $50,000 per year and have your 30 years in, your pension would be $2000 per month ($50,000 times .48 divided by 12 months). That is the amount you would be entitled to as a retirement benefit. Instead of that check going to you, it is deposited into your DROP account. After five years, at the current 6.5% interest rate, your DROP amount, that would be about $148,000. Of that $148,000, approximately $127,000 is your pension contribution into the plan (which is unaffected) and the other $21,000 was the interest.
Calculating with the new interest rate of 1.3%, your DROP amount will be approximately $132,000. The $127,000 which is your pension contribution doesn’t change, but the interest earned drops to approximately $5,000. You are losing about $16,000 worth of interest over the 5 years with the lower rate. Instead of $148,000, you would now be getting approximately $132,000. That is a decrease of less than13% over the 5 year period!
If you are a FRS special risk participant with an average final compensation of $50,000 per year and have 25 years in, your pension would be $3,125 per month ($50,000 AFC multiplied by (25 years of service times the 3% service credit). After 5 years of DROP, and those pension checks deposited into your account, the 6.5% interest rate your DROP amount would bring your total DROP amount to be about $234,000. Of that amount, approximately $199,000 is your pension contribution into the plan (which is unaffected) and the other $35,000 was the interest.
Calculating with the new rate of 1. 3%, your DROP amount will be approximately $206,000. The $199,000 which is your pension contribution doesn’t change, but the interest drops to approximately $7,000. You are losing about $28,000 over the 5 year period. Instead of $234,000, you would now be getting $206,000. Again, the amount you accrue at 1.3% is a decrease of less than 13% if the rate were the original over the 5 year period)!
Please don’t get me wrong, it is less, BUT it is not a fatal blow. That part of your nest egg may be cracked, but it isn’t necessarily broken! If you believed the DROP was your best option before, it very well still could! It would be wise to discuss this retirement option along with the other options with a trusted advisor.
Considering the legislators wanted to totally eliminate the DROP as of July 1, lowering the interest rate is simply not that bad, and the DROP will still be a nice supplement to your retirement. We urge you to discuss this with a financial advisor that is knowledgeable about your situation and the Florida Retirement System and it options.
Projections used in this illustration are estimates. Consult the Florida Retirement System for you actual amounts.