DROP – The Holding Bin for Your Pension Check
DROP is a program that allows you to retire without terminating your employment while your retirement benefits accumulate in a separate account earning 1.3% as of July 1, 2011. Previously, the earnings rate was 6.5%. In essence, you retire under the FRS Pension Plan and then have the ability to aggregate a lump sum cash benefit. At the end of your DROP period of 5 years, you must terminate employment. For a more complete description of DROP, please refer to the Frequently Asked Questions about DROP prepared by the State of Florida Division of Retirement available within www.myfrs.com.
DROP is not extra money or some kind of bonus. It is simply holding your pension check while you are continuing to work for the State. DROP participation means you retired under the FRS Pension Plan based upon your years of service at the time you elected DROP participation. By retiring at that time, your subsequent retirement benefit that would accrue over the next five years is set aside in a lump sum payment. However, your monthly check that you receive from the FRS Pension is less than it would be since the five years you spend in DROP do not count for the FRS Pension Plan calculation. In addition, the earnings rate on these DROP monies has been reduced from 6.5% to 1.3%. This drop in interest rate really undermines the value of DROP particularly considering that your years in DROP don’t increase your benefits under the Pension Plan.
The DROP balance should be rolled over to either the FRS Investment Plan or an Individual Retirement Account (IRA) upon leaving the state’s employment in order to properly manage taxes and retirement income. This rollover should be done properly in order to avoid full taxation of the lump sum amount. As you use this DROP amount to provide retirement income, regular income taxes will apply. By using an IRA you set the proper tax withholding rather than being subject to the 20% mandatory withholding that applies for direct DROP or FRS Investment Plan withdrawals.
However, if you are under the age of 59½ at retirement than you want to roll your DROP over to the FRS Investment Plan if you plan to use your DROP monies over time. Assuming you meet certain parameters (over age 50 and special risk or over age 55 and regular class), you are able to avoid the 10% penalty for early withdrawal by drawing directly from DROP. Alternatively, you could use the FRS Investment Plan (if over age 55) to provide penalty free access to these DROP monies over time. A major distinction between DROP and the FRS Investment Plan is that the DROP rules specifically recognize the age 50 public safety employee exemption as an exception to the normal 10% early distribution penalty. Meanwhile, the FRS Investment Plan does not specifically recognize this age 50 exception and only provides for the usual age 55 exemption. This is where your age, your job and where your money winds up starts to really matter if you want to reduce your taxes in retirement.