The DROP basics for Special Risk Participants

“DROP” is an acronym for Deferred Retirement Option Program. FRS added the DROP program to the Pension in 1998 as a way to induce employees to work longer, in an attempt to keep employees from retiring as soon as they are first eligible. Agencies realized that it cost far less to provide a DROP benefit for a current employee than it would cost to recruit and train a NEW employee. So, in 1998 the Florida Retirement System (FRS) instituted a program that could entice experienced employees to continue to work for up to five more years and at the same time allow them to accumulate a lump sum of money that would be available at retirement – the DROP.

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The DROP basics for Special Risk Participants

DROP is an acronym for Deferred Retirement Option Program. FRS added the DROP program to the Pension in 1998 as a way to induce employees to work longer, in an attempt to keep employees from retiring as soon as they are first eligible. Agencies realized that it cost far less to provide a DROP benefit for a current employee than it would cost to recruit and train a NEW employee. So, in 1998 the Florida Retirement System (FRS) instituted a program that could entice experienced employees to continue to work for up to five more years and at the same time allow them to accumulate a lump sum of money that would be available at retirement – the DROP.

Since public sector employees may find it difficult to accumulate significant wealth on their often moderate salaries and have had little chance to accumulate wealth in a retirement plan (outside of IRAs or Deferred Comp), the DROP was initially very attractive. It was the only real way to get a decent pension, AND a nice lump sum of money.  If your only other retirement benefit is a pension, it is wonderful, but, if you DROP, you effectively retire! You will get no future credit for years of service or higher pay.  Instead, you accept a significantly lower pension amount in exchange for the potential lump sum.

FOR SPECIAL RISK PARTICIPANTS, (regular participants get reduced amounts.  See the Civilian section)

ELIGIBILITY

You are eligible to participate in DROP when you are vested (after 6 years) and have reached your normal retirement date. Your normal retirement date is the earliest date at which you are entitled for unreduced benefits based upon your age and/or service credits. For FRS special risk, that is 25 years of creditable service, OR, you are age 52. If you are under 52 and attain 25 years of service, you may defer the DROP until age 52.

HOW TO DROP

To participate in DROP, You must make the election within a 12-month period starting when you reach normal retirement age (25 yrs of service or age 52).  You may make your election up to six months in advance of your normal retirement date, and no later than the month you are to begin DROP.  If you do not apply within the required window, you will lose your eligibility to DROP. Again, if you complete 25 years of service before you reach age 52, you may defer your DROP election and begin DROP anytime between completing 25 years of service and reaching age 52.

LIMITS

You may participate in DROP for a maximum of 60 months from when you are first eligible. Your eligibility begins the first month you reach your normal retirement age after 25 full years of service or reaching age 55.  Even if you qualify to defer entering the DROP, you only get a maximum of 60 months in the DROP, you just get to begin a few years later. This could be a huge benefit if you qualify.  It means it may be possible to get extra retirement benefits than normally possible.  For example, the pension caps at 100% of your average final compensation, but if you have 33 years of service at age 52, and and then DROP, you may get 99% of AFC, AND Five years of DROP eligibility! If you don’t qualify to defer your DROP participation and you apply for DROP after your DROP eligibility period has begun, your maximum 60-month DROP participation period will be reduced for each month your application is delayed. To simplify, you can only WORK for a maximum of 60 months from the first eligible DROP date if you choose to drop, and that 60 month period starts from your eligibility date, not your selection date. If you attain 25 years of service, but do not elect drop for 3 months of your 26th year, then you are only eligible to DROP for 57 months. Once you elect to DROP, you must terminate employment by the 60th month after your first eligibility date, and the election can not be reversed!

THE BENEFIT

There is no smoke or mirrors, nor financial magic to the DROP.  For all intents and pension purposes, you have retired, and you have started to collect your pension.  Because you are retired, your Pension is capped.  Your DROP benefit is simply your normal pension benefit paid monthly, but instead of the check being paid to you, it is deposited into your DROP account, where it earns interest (currently 6.5%). It is basically simple math. The DROP period allows you to work for a longer period, and your pension is paid into a special account until you must quit working (maximum of 60 months).  At 25 years of service, that amount is 75% of your average final compensation (your average pay over the last five years). Please refer to MyFRS.com for the DROP calculator, or see the chart below. Because you are retired, your Pension is capped, and you get no additional retirement benefit for additional years of service or raises and promotions!

The DROP benefit is also increased by a 3% cost-of-living adjustment each July first.  The first COLA will be prorated based on the number of months you were in DROP prior to July 1 if less than 12 months. Example :  If your Average Final Compensation is $50,000, your monthly pension would be $3,125.  Each month $3125 is deposited to your account, and earns 6.5% interest.  On July 1 of each year, your monthly deposit is increased by 3%.

The chart below can help you calculate what your total DROP account would be worth after each year in the program, based on the monthly benefit on the left.  In our example above, the DROP value at the end of 5 years would be a little more than $223,218.

Monthly

Years of Participation in DROP

Benefit

1

2

3

4

5


$100

$1,235

$2,588

$4,067

$5,681

$7,441

$500

$6,177

$12,940

$20,334

$28,405

$37,203

$800

$9,883

$20,704

$32,534

$45,448

$59,525

$1,000

$12,353

$25,880

$40,668

$56,810

$74,406

$1,500

$18,530

$38,820

$61,002

$85,215

$111,609

$2,000

$24,707

$51,760

$81,336

$113,620

$148,812

$2,500

$30,883

$64,701

$101,670

$142,025

$186,015

$3,000

$37,060

$77,641

$122,004

$170,430

$223,218

$3,500

$43,237

$90,581

$142,338

$198,835

$260,421

$4,000

$49,414

$103,521

$162,672

$227,240

$297,624

$5,000

$61,767

$129,402

$203,342

$284,054

$372,037

After 5 years in the DROP, you would receive your monthly benefit of $3125 plus cola, AND you would have approximately $225,000 in your DROP account.


COLLECTING YOUR DROP BENEFIT

The proceeds of your DROP account may be distributed to you in one of three ways. You may take a lump sum payment of the entire amount, a direct rollover into an IRA or other qualified retirement account, or a combined partial lump sum payment and rollover. You must make your election with 60 days of your employment termination date. If you don’t select another option, you will automatically receive a lump sum payment for the entire amount, less 20% mandatory tax withholding, and the balance of taxes due will be payable by you to the IRS the following April 15th. The amount taken as a lump sum will be added to your other income for that year, and will be taxable at the tax rate due for your other income PLUS the entire lump sum amount. If you take a lump sum DROP benefit of $225,000, and you have $30,000 of other income that year,  your tax bracket for that year will be based on the entire $255,000.  Most likely you will be in a 30% tax bracket for that year.

By rolling the money into an IRA, you can continue to defer the taxes, and the money will continue to grow tax deferred, based on how you invest it.  You will only be taxed on any amount you withdraw.

An Example of Potential TAX CONSEQUENCES

DROP value of $225,000

If you withdraw the lump sum, $45,000 will be withheld automatically, leaving you $180,000.

The full $225,000 will be included as income on your tax return for the year you take the lump sum distribution, putting you in a tax bracket somewhere above 30%.  The balance of your taxes will be due on April 15 of the following year.  Assuming 30% tax rate, you will owe another $22,500 on Tax day, leaving you with $155,000.

Depending on your age, you may also have to pay a 10% tax penalty for a premature distribution, which could further lower the amount by another $22,500 to leave you with only $132,500 of your original $225,000!

Obviously, rolling the money into an IRA, investing it wisely, and only taking distributions as needed, will allow you to not only preserve the money, but allow it to grow to better provide for your future.  In addition to expanding your wealth, an IRA provides you with some control over your future, and the future of your spouse and children.