How can a simple program supercharge your retirement income strategy?
In this episode, April Schoen breaks down the intricacies of DROP, The Deferred Retirement Option Program, and its latest updates impacting your financial future.
In this episode, you’ll discover…
The enticing benefits that make the DROP program a game-changer.
Key eligibility changes in 2023 that could affect your retirement timeline.
Various pension options within DROP and how they cater to different retirement goals.
The significant pros and cons that you'll need to weigh before opting for DROP.
Strategic ways to manage your DROP payout to maximize retirement benefits and minimize taxes.
Mentioned in this episode:
Transcript:
April Schoen: Hello and welcome to another episode of The Secure Retirement podcast. I am one of your hosts, April Schoen, and today's episode is dedicated to understanding the DROP program, which is part of the Florida Retirement System. Now DROP stands for deferred retirement option program, and it's really a unique planning tool that's designed exclusively for FRS pension plan members who qualify for normal retirement.
How the DROP program works is it offers a way for you to retire on paper while continuing to work in your position and continuing to earn your salary. And then what happens while you're in DROP is the state actually starts paying out your pension benefits, and they pay those into a dedicated retirement account that's just for you.
And those pension payments, they go in every single month while you're in DROP, and it earns interest so that when you exit DROP, when you officially fully retire, now you start receiving the pension payments as income, and you also have a lump sum. Sometimes you'll call this like my DROP amount, or my DROP account.
So we're going to talk about today is, what are some of those common questions we get about DROP. What is it? How does it work? I'm going to tell you about a client that I worked with recently who is deciding if he should go into DROP or not. And just really want to dive deep into this topic, because we get a lot of questions about this.
So first, let me talk about some of the highlights of the decisions that you might be facing when it comes to DROP. So recently, I worked with a client, and he's at a crossroads. He's 55 and he's eligible to go into DROP, but he's considering his options. He could go into DROP now work five more years and then fully retire at 60.
By going into DROP when he fully did retire, and he came out of DROP, his pension, monthly pension payments would be about $4200 a month. That's what he would get. And he'd also walk away with a significant DROP payout of almost $275000. Now, the other option choice that he has is to not enter DROP at all, just continue working those five more years. So he gets five more years of service credited, and this would increase his pension to about $5300 a month.
So it's definitely higher than if he had gone into DROP, but he wouldn't have the lump sum. So why might he choose one option over the other? Well, let's, let's break down some of his choices. By going into DROP, he's gonna have this guaranteed lump sum when he fully retires, and he can use this to help him with other goals, and investments. It could provide immediate flexibility, and financial security in a way that just getting that higher pension payment might not.
The pension is not liquid. It's not flexible. You can't go to the state and say, hey, could you send me an extra $10,000 this month because I need a new air conditioner, or I got to get my roof repaired. So the DROP account gives him flexibility by having access to this lump sum.
And then it's going to give him more control over his choices because he's going to have lots of options about what to do with his DROP account, which is what we're going to talk about in a little bit. But he could roll it over into an IRA or another tax-deferred account, which is going to let him control how and when he uses those funds. He might choose to invest those for growth, create additional income streams, or even have it be part of the legacy that he leaves for his family.
Also going into DROP gives him a structured retirement timeline. He knows, hey, for him, it was five years. I know that I'm going to be retiring at the end of five years. And hey, I'm going to have this pension, I'm going to have this lump sum. But for some, it's having this defined exit date that makes financial planning and future lifestyle choices so much easier.
You've got that date circled on the calendar that you know is coming, and it gives you time for about five years or eight years, you can be in DROP to make changes. Sometimes I have clients who say, well, you know what, April, I want to make sure I have all my short-term debt paid off by the time I exit DROP. Or I want to build up my savings, or we want to go ahead and buy a car and have it paid off.
We want to do some remodeling at the house before I step off into retirement, because we know there's this date in the future, and we've got time. We've got five to eight years for us to get some of these things done before we actually retire. And obviously, his pension is going to be lower with DROP, but he's going to have both this steady income and he's going have access to this lump sum, which is going to be helpful for large expenses or unexpected costs in retirement.
And it can also help him do some other planning with some of his other assets. So let's talk about now, though, why would maybe he choose not to go into DROP? Well, first, by skipping DROP he's gonna significantly increase his pension. I mean, going from $4200 to $5300 a month, that's a big difference in guaranteed lifetime income. And for some who are focused on that stability, this could be something that's really important to them, especially if you're concerned about longevity or inflation.
The higher pension is going to give him more discretionary spending ability without having to rely on the market or other income sources. And this could definitely be beneficial if he thinks that expenses are going to be higher in the future, or if he just wants to have more financial independence each month. Now, again, he's not going to have that lump sum, but maybe he's okay with that. Maybe he has other assets to offset that.
He may not need a large, immediate payout. It could be that having those higher pension payments allows him to maximize his lifetime income, especially if he plans to say, hey, I'm going to live a really long time in retirement, and he wants to reduce how much he has to rely on other savings and investments.
And then by not taking DROP, he doesn't have to worry about some of the tax impacts of DROP, which we're going to talk about in a little bit, about what you do with your DROP payout. And you really got to pay attention to the tax side. Obviously, with the DROP, you can roll it over into an IRA, but at some point, you have to start taking money out of that.
So there's also some tax planning to consider. So you can see as going through this scenario, that it's a big decision. I mean, you're talking about changes in your monthly income. You're talking about, for him, specifically, you know, a DROP payout of over $250,000.
That's a lot of money for you to decide what you're going to do with it and are you going to go down that route, that path. So you can see how it's really important that you investigate and research both sides to see how it's going to impact your retirement. So now let's take a few steps back here and go through and talk about what is DROP and how does it work.
Well, DROP is a voluntary program that lets you effectively retire again, the state considers you retired on paper when you go into DROP, but you defer your actual termination for up to eight years. So when you go into DROP, it used to be five, but they changed it. You can now be in DROP for eight years. So this means you continue to work in your same position. You're earning a salary, but at the same time, the state is starting to pay out your pension payments, but it's accumulating into a dedicated retirement account that's for you.
So when you enter DROP you're considered retired for the purpose of the pension payments. So that means you stop earning those additional retirement service credits, and then your monthly pension benefits, they begin accumulating in a retirement account, rather than being paid out to you.
So they're going to go in tax deferred. You don't pay any taxes while your money's accruing in the DROP. And this balance is going to grow both by how much is being paid in by your pension and then also the interest that it's earning. And since all of this is going to go in tax-deferred, you're only going to pay taxes when you start to take your DROP out. Either you could do a lump sum or as you're taking money out as income.
And the beauty of the DROP program is that it kind of lets you have the best of both worlds. You get this financial security of I'm still going to have my pension, but I'm also now going to have this lump sum that I otherwise wouldn't have. Or I'm going to have it in addition to what I've saved in deferred comp, what I've saved maybe in other savings and investments.
So it gives you some more flexibility and control and helps you maximize your retirement savings. That's going to help you transition into full retirement. So you may be wondering, okay, April, this all sounds pretty good so far. So how, how do I participate in DROP? How do I know if I'm eligible?
Well, to participate in DROP, you need to be vested in the pension, and you have to be eligible for normal retirement age, which is going to be based on your years of service and your age. It also depends on when you started with the state because in 2011 they had made some big changes about what is a normal retirement age. So you gotta be of normal retirement age or have a certain number of years of service to go into DROP.
Now, I mentioned a few minutes ago that in 2023 they made some big changes to DROP, and one of the things they did was they extended it from five years to eight years. Now it doesn't mean that you have to be in DROP for the full eight years. It just means that the longest that you could be in DROP would be up to eight years. They also increased the interest rate that you earn.
It used to be 1.3% but now that's increased to 4%. Which is a huge increase in how much interest you're earning. So let's talk about what are some of those key decisions that you need to make about entering into DROP. So should you go into DROP? Here are some things you want to consider. You want to think about your personal financial goals.
Is having that DROP payout, is that going to help you in retirement? Is that going to accommodate and compliment your retirement income goals that you have? How happy are you in your job? Are you comfortable with working in your same position for another eight years? Now, like I said, you don't have to work the full eight years.
You could do two years or five years. It's really up to you, but that is one things that you want to consider is are you going to be okay continuing to work in that position for the duration of DROP? But there are a lot of people will look at those numbers, and it's a big jump as your account continues to accumulate that they want to hold out for the full five years, or they want to hold out for the full eight years. So take that into consideration.
Also, your pension amount is going to be set, because once you go into DROP, they consider you retired, so you're not going to get any more service credits. So if we think about how the pension is calculated, and it's a formula of taking your highest five years of salary, and then also a formula of years of service. So when you go into DROP that stops. So think of it like your pension being frozen.
I mean, you're still going to get a cost of living adjustment, though, that still happens even when you're in DROP, but you are locking in those years of service. Again, one of the benefits is that you're going to get this lump sum at the end in addition to your regular pension. I mean, I can't tell you how many clients that I've worked with that when they get to that part, they're exiting DROP, that their DROP account is the same amount of money that they have in their deferred comp.
So think about that for a second. Here's this retirement account that they may be having saving in for most of their career, and it's the same amount of money that's in their DROP account. And at those times that was over that five-year time frame. So it's not a small amount of money we're talking about here. Now, again, we did talk about some of the negatives of limited pension growth.
So again, your pension benefit is frozen, but you do get that cost of living adjustment every year. And then what if things change, and if you exit early, this might impact your lump sum. It's not might. It will impact your lump sum. So I'm thinking about a client of mine a few years ago who was in DROP, and she was three years in, and her mom had some major health issues, and she had to step away from work.
She basically had to end her DROP at three years and instead of five. So her pension was much, excuse me, her DROP account was much lower, and then her pension is lower too because she didn't get all the cost of living adjustments. So that's definitely something that you want to consider. And then also remember that when you go into DROP is when you again retired on paper.
So this is when you have to choose your pension option. So which pension option are you going to choose? Because that's when you make the decision, is when you go into DROP. And it's an irrevocable decision. So once you enter DROP, your pension option is locked in permanently. So this is so crucial for you to review your options and understand the impact of on your long-term income, for your spouse, and for your heirs.
So let me just give you one. I'll kind of run through those four pension options so you can understand how they work. But option one is going to be what we call lifetime benefit only. That means the pension is going to be paid to you, the employee, for your lifetime, for as long as you're living, but the day you die, the pension dies with you.
So option two is life to you, the employee. You get it for life, but it gives you a 10-year guaranteed period where if you pass away in those 10 years, a benefit is going to continue to your beneficiaries. Whoever that is. Could be a spouse, a child, but just know when you go into DROP is when that clock starts on that 10 years. So if you're in drop for eight years, and then you exit DROP, well, you only have two years left on this guarantee.
Option three is joint with 100% to the survivor. So usually this is for spouses. So this says I get this pension for as long as I'm living, and the day I die, my husband gets it for the rest of his life, and he's gonna get the same amount of income. There are no changes for either one of us.
Now, option four, though, is where there's a lot of confusion. So I want to make sure I go through this one. Option four says that it is joint with two-thirds to the survivor. But what happens with the survivor benefit is it's when either spouse passes away. So let's say that I worked for the state, and it's my pension benefit, and I'm just gonna make the math easy here. And let's just say that my pension is $2000 a month.
So what happens is, my husband and I get this pension the $2000 a month for as long as both of us are living. But when one of us passes away, that could be me, the employee who worked for the state, or it could be my husband, who didn't work for the state. Either one of us passes away, the pension gets reduced down to two-thirds.
So now what happens is my $2,000 a month is now $1,320 a month. So it's a big drop, especially in those situations where it happens to be that the non-pension plan spouse passes away first. So make sure, when you're making these decisions that you're looking into all options, and really taking into consideration with everything else in your financial world, not just this one piece. So let's talk about here the pros and cons.
I want to summarize some of these pros and cons we talked about going into DROP. So some of the benefits. This lump sum accumulation, you've got the potential for a significant payout upon retirement. You're going to have that steady income already from your pension, of course, but you're also going to have that lump sum in that tax-deferred account. So this is going to give you the opportunity to have flexibility, and control.
Maybe it lets you plan for major expenses, and investment opportunities. Lots of more choices and liquidity, because you've got access to that lump sum. The negatives are that fixed pension benefit, because, again, you're going to lose those additional pension credits, those years of service while you're in DROP.
But you do get your COLA, but it is going to impact your pension payout. And this may also help from some tax standpoints because you don't have the lump sum to worry about. Because then we don't have to worry about, what do we do with this drop amount and the retirement account, and how all that's going to impact you from a tax standpoint. Now let's say you're already in DROP.
What happens when you exit? What happens when you leave DROP? Well, when you transition from DROP to full retirement, now you're going to start getting your pension payments as income, and this is when your DROP account is going to be accessible. This marks the transition from accumulating benefits in DROP to now you're receiving that pension payment directly, and you're going to have to decide, what do you do with your DROP payout?
And there are only a few options. One, you can do a lump sum payment. So this allows you to take the total DROP balance at once. But remember that all of this has been in a tax-deferred account, so every dollar that you take out is going to be taxed at your highest marginal rate. That's why, for most people, that lump sum payout is not a good option.
You can also roll it over into another tax-deferred account. That could be an IRA, that could be deferred comp. This is going to help you avoid those tax liabilities, and it's going to give you more control. Like we talked about earlier, where you can invest it for growth, you could invest it for income, you could have it be set up to go as a legacy.
It's gonna give you flexibility, choices, and control about what you do with it. Some may choose to actually take that DROP payout and turn it into an annuity, so they've got additional guaranteed income. Now that is attractive for people who say, hey, I want more income, but I also want to have the liquidity that's available in some annuities. But taking that as a reminder, we've got to think about those tax implications, because taking that payout as a lump sum, it's going to be taxable, could push you into a higher tax bracket.
And then rolling it over, defers those taxes until you withdraw, allowing you again to have more tax-deferred growth. And as of today, as I'm recording this in November of 2024 you can let those retirement account funds grow until you're 73. But at 73 you have to start taking money out of any pre-tax vehicles like IRAs, deferred comp, 403b's 401k's as for your required minimum distribution.
So keep that in mind. So how do you decide what to do with your DROP payout? Well, first you want to think about your retirement timeline. When are you going to need to access those funds? Do I need income right away when I retire? Or am I going to let it grow for the future? What are my goals? Do I have any big financial needs coming up? Do I need to help pay for health care or travel or support family? Do I have savings or investments elsewhere?
So rolling over that DROP might help you have greater control. Maybe it's something where you look at doing Roth conversions, for example. Lots of different options available to you. One of my clients recently retired and she's got her DROP account, and we're doing a couple things. One, she's gonna do some renovations to her house, but we looked at her options and decided it was gonna be best for her to wait until the next calendar year, because of taxes, to start taking money out of DROP.
So what we did is we had the whole DROP balance go into an IRA, and then that way, she can control when she takes the money out and for what purpose. So for part of it, she's going to be using for renovations next year, and then the rest of it, we're going to let it continue to grow because she doesn't need income from the rest of it yet.
She's got her pension, she has social security, she's got money accumulated in deferred comp, and so she's got other assets to tap into for income, so we're gonna let this account continue to grow. And she's 67 so she's got six years before she has to start taking money from it. This was a great opportunity for her to have that grow.
So again, you want to think about what are those financial needs that you're going to have and consider those investment choices. Are you going to do a lump sum? Are you going to do a rollover? Are you going to look at an annuity? What investment options are you going to look at? And this is when you really want to work with an advisor. Because each option has very unique tax implications. It's going to impact your overall financial plan.
So this is really when consulting that financial advisor, consulting that tax advisor is crucial to make the most informed decision. An advisor can really help you look at your income needs, look at tax planning, and legacy goals, not just one piece of the puzzle, but the whole thing. And they can help you look at both options.
Like I was talking about with the client earlier, of hey, does it even make sense for him to go into DROP or not? And for him with these other financial assets, yes, going into DROP is going to be a very good decision for him. But it's not one size fits all. It's not a hey, everyone should always go into DROP or no, you should never go into DROP.
It really does come down to your individual situation, and this is why it's so important that you work with an advisor, someone who can walk you through that and show you both sides. Now, some other kind of common questions that we get are, what happens if I leave early? So yeah, you can leave early from DROP but it's going to reduce how much accumulates in that DROP balance, and it's obviously going to impact how much you're getting in that pension payment, too.
One thing is, you want to make sure that you coordinate this with your other retirement accounts. So again, think if you have old 401k's, or you have a 403b or 457 plan, how is this all going to work together? What about also social security, and where does that fit in? Sometimes we might find where someone uses DROP to actually bridge the gap for income so they can let their Social Security grow longer.
We defer taking Social Security, and maybe we're using some of that DROP to bridge the gap for income. Or the opposite. You might look at it and say, hey, for a couple, we need to turn Social Security on for one and let the other one grow. So there's definitely some planning that you can do there.
And then DROP does have some flexibility. Because, like I said, if your situation changes, like, maybe your health changes, or you've got a family member that has changes. Maybe there are changes in your position and job in your department. I had a client come in who said, you know what, I thought I was going to be in DROP for the full five years, but they're going to be implementing a new software system, and I don't want to do it again.
I've already been through two major software changes, and I don't want to do this a third time. So she chose to leave DROP early and didn't hit her full five years. So we just want to understand how all that's going to work, and so that you can see what your options are. And of course, you want to take into consideration future healthcare needs. If that's going to just be part of your overall retirement plan.
Healthcare costs can really impact your overall retirement income and expenses. And so you can see here that deciding to go into DROP or not is really an individualized choice. It's not a one size fits all. You think back to that client I mentioned earlier, and how important it is to really weigh those immediate financial gains against long-term benefits. And that's why it's so important to work with someone who can guide you through a personalized analysis and show you the impact of both choices.
So don't just assume that going into DROP or delaying retirement is always the best. You really want a tailored approach that's going to help you make the most informed decision for your unique situation and goals. So if you're considering going into DROP, if you've got questions about how it fits into your retirement strategy, I'd recommend you reach out to our team, and let's explore these options together.
So the best way to do that, I would say, would be to go check out our website, and we'll link it in the show notes. But it's curryschoenfinancial.com. You're gonna see access to all of our podcast episodes. There's a link to book a call. You can request our information package, and so just definitely some resources on the website.
And like I said, links to to the podcast as well. But I just want to say thanks for joining me today as we're exploring this. I think it says a lot about you that you're taking the time to understand this important benefit. And we look forward to seeing you either on one of our webinars or a future podcast. Bye now.
Voiceover: This promotional information is not approved or endorsed by the Florida Retirement System or the Division of Retirement. Neither Guardian nor its affiliates are associated with the Florida Retirement System or the Division of Retirement. This material is intended for general public use. By providing this content, Park Avenue Securities LLC and your financial representative are not undertaking to provide investment advice or make a recommendation for a specific individual or situation, or to otherwise act in a fiduciary capacity. If you'd like additional information about our services, visit our website at curryschoenfinancial.com, or you can call our office at 850-562-3000. Again, that number is 850-562-3000. This podcast is for informational purposes only. Guest speakers and their firms are not affiliated with or endorsed by Park Avenue Securities, Guardian, or North Florida Financial, and opinions stated are their own. April and John are registered representatives and financial advisors of Park Avenue Securities LLC. Address, 1700 Summit Lake Drive Suite 200, Tallahassee, Florida, 32317. Phone number, 850-562-9075. Securities, products, and advisory services offered through Park Avenue Securities, member of FINRA and SIPC. April is a financial representative of the Guardian Life Insurance Company of America, New York, New York. Park Avenue Securities is a wholly-owned subsidiary of Guardian. North Florida Financial is not an affiliate or subsidiary of Park Avenue Securities or Guardian.
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