So … Should I Drop ????? for Special Risk participants.
Before we decide, let’s take a look at why we even have a decision to make. FRS added the DROP program to the Pension in 1998 as a way to induce employees to work longer. Prior to 1998, an FRS participant had no options – they retired and received a monthly pension check. End of story! FRS further expanded the range of retirement options in 2002 with the addition of the FRS Investment Plan. This change was significant! Now a FRS Participant has several different retirement options to choose from. There is still the basic Pension, there is a combination Pension and the DROP (Deferred Retirement Option Program), and after 2002, a third alternative whereby you can participate in the FRS Investment Plan, and take control of how your retirement money is invested. You also have a fourth option, which is to “roll” the current value of your retirement into a self-directed IRA account at retirement.
Each choice has it’s own special characteristics.
A rollover allows you take control of your money, and it becomes your money, and it instantly increases your net worth by the total amount. (For a Deputy with 25 years in, this will average somewhere around $750,000). The rollover feature of the Investment Plan makes the DROP somewhat less attractive for many participants.
With the Investment Plan, employees can opt out of the pension plan at retirement, and transfer the entire value of the retirement benefit into the Investment Plan. You then choose from a selection of investment options in order to manage your own retirement plan. The current value of your retirement plan is the amount of money that would be needed to pay you your pension for the rest of your expected life (IRS actuary table put that at around age 85) , an amount that could be substantial!!! The income can be affected by the value of the account, and more importantly, the value of the account goes directly to your spouse or children, or whomever you wish it to go to. This is attractive to many. With the Pension plan, any value goes back to FRS, and not to your family!
So, should I DROP???? MAYBE! Contrary to popular belief, the DROP is not the end-all for everybody. There are many important factors. Do you plan to promote soon or are you at the highest pay scale you plan to achieve? If you are promoting soon, you may want to wait to lock in that higher pension amount because of the increase in your base salary. Will you want to leave the job in 5 years? Some people are not ready to make this commitment. Once you choose to enter the DROP program, you will not be able to work more than 5 years longer, so you should be mentally prepared to retire. One of the most important is whether your benefits will grow more in the drop account, or in your pension account. It is likely there will be no financial gain in the DROP for most participants. Therefore it might be better if you don’t DROP!
By not dropping you have several potential benefits;
* You may work as long as you like, and not the maximum 60 months.
* You may decide at the time of retirement to take a pension, a pension and lump sum, or a lump sum of the entire value. It is fairly easy to select a combination pension and lump sum that would be no worse than the DROP benefit, and could be substantially better!
* You will still be eligible to gain retirement benefits from pay raises and promotions!
* You will gain 3% per year of service until you max out at 100%. The Lump Sum value of higher pay at 90% is better than the Lump Sum value of 75% of your AFC five years ago!
* You will still be eligible for Active Duty Benefits that you lose in the DROP
* You continue to accrue credit for the Health Subsidy account that you lose in the DROP
Before the Lump Sum Rollover option was available, the DROP was attractive. It was the only way to get a pension AND a lump sum.
Years of service and age have significant impact on how your benefits continue to accrue. If you DROP at 75% benefit, it is most likely not the best option. If you can defer the DROP, and get a 90% benefit or more, the DROP is well worth it. Anything in between requires a little math to be sure! It is important to remember – from FRS’ perspective, there is no difference (the costs are relatively the same or less for FRS), which translates into no gain for you, and possibly a loss in most cases. In most cases, there is little or no financial gain derived from the DROP, rather retirement dollars are simply allocated in a different payout choice. It does give an relatively younger employee who has “maxed out” their retirement benefit (you are eligible to defer the DROP) to earn additional benefits for retirement. Any difference in the value of benefits can be calculated, and an educated determination of which option to choose can be made. Each employee should make a determination based on his unique situation, and not presume any one method is better simply because it may be more popular.
Example 1 – DROP at 25 years.
You enter the DROP at 25 years of service, and continue to work for the maximum 5 years in DROP. The benefit is now $37,500 in pension income (locked in at the time of entering DROP based on AFC of years 20 thru 25), plus a DROP amount of approximately $225,000.
Example 2 – Don’t DROP, work 5 more years.
You are a special risk FRS employee with 25 years of service, making an average final compensation of $50,000, and are 50 years old, would be eligible for a pension benefit of 75% (3% per year of service) or $37,500 per year. The Lump Sum value of your retirement will be close to $750,000. If You choose NOT to DROP, and just continue to work another 5 years to age 55, the benefit would then be 90% of the average final compensation over the next 5 years,(which will most certainly be a higher AFC due to pay increases and promotions). If we assume pay goes up by at only 3% per year, the pension benefit would be approximately jump to $48,000 per year (90% of AFC of $54,000). That represents a starting benefit approximately 28% higher than the benefit of retiring at 25 years of service. More importantly, your Lump Sum value will be closer to $1,000,000.
Example 3 – Defer entering DROP, work
You have 25 years of service, but you are only 46 years old. You defer the DROP until you are 52. Now, at age 52, and 31 years of service, you enter the DROP. Your pension benefit is nearing the “max-out’ point (100% of AFC) at which no further pension benefits could accrue. He is now eligible to lock in a pension income of 93% of his AFC, which with 3% cola, would be approximately $59,000 per year – Plus he can now accrue 5 years of DROP money, now based on $55,000 AFC, which would be close to of $400,000 per year.
Example 4 – Work as long as you wish.
Work as long as you wish. At retirement Rollover the entire amount into an IRA, and have the freedom to choose more or less income, increase your net worth by the entire amount. Take out lump sums as you need, or desire. Protect your family at no additional cost or loss of benefit by giving them the balance at your death. Have the freedom to take control of your future! The Pension is a very safe, low risk and low return option. By assuming a comfortable amount of risk for you, you might substantially increase you standard of living in retirement.
Obviously, there is not an option that is good for everyone. While the pension is a good pension, and the drop may have some advantages for some people, it is essential that you sit down with someone knowledgeable about the options, and figure out which one is best for you. Our experience is that the FRS web site, while comprehensive, may not be the most user friendly to navigate. At FRSOptions, we are well versed in helping you navigate the site for your best advantage.