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How Deferred Retirement Option Plans (DROPs) Work

Deferred Retirement Option Plans

Deferred retirement option plans (DROPs) are of benefit to both employees and employers. In exchange for continuing to work past your eligible retirement age, an employer will set aside annual lump sum payments into an interest-bearing account. Upon retirement, the money that has grown in this account will be paid to you, on top of the rest of your accrued earnings. If you have more questions or want some help getting your retirement plans together, consider talking with a financial advisor.

What Are Deferred Retirement Option Plans (DROPs)?

A deferred retirement option plan, or DROP, is a way for an employee who would otherwise be eligible to retire to keep working. Instead of continuing to add new years of service – thereby increasing the employee’s pension benefit amount – the employer will begin placing lump sums into an interest-bearing account annually.

When the employee finally retires, they will receive the full value of this account, in addition to their established pension benefits. This allows the employee to start earning some retirement benefits, while the employer gets to retain the employee’s services (without further increasing that employee’s pension payout).

Most DROPs are for public sector employees, like police officers, firefighters and teachers. This is both because these plans were first introduced by government employers and because few private companies offer pension plans anymore. More specifically, a DROP would apply to someone who:

  • Has a defined benefits retirement plan from their employer (typically in the form of a fixed pension)
  • Is of retirement age, but chooses to continue working

What Goes Into Calculating DROP Benefits?

Because DROP plans are offered by so many different employers, the specifics of each plan can vary. Here’s a quick rundown of some of the most important factors to look out for:

  • Participation Length: Most employers won’t let you participate in a DROP indefinitely. Instead they typically offer a window of time called a “participation limit.” Some plans suggest employees participate for a maximum of seven years, but four years is common in many cities.
  • Payment Amount and Interest: Each employer will specify how much they’ll pay into your DROP account, how it will gain interest and how much that interest will be. DROP payments often equal the normal retirement benefits you would have received during this period, but not necessarily.
  • Health, Worker’s Compensation, Disability and Other Benefits: Sometimes a DROP may classify you as “formally retired,” but still working. Under this formula, many previous benefits may no longer apply. So if you’re considering a DROP, be sure to determine the status of your other benefits. This protection usually ends once you officially retire.
  • Dispersal and Taxes: All DROPs will pay you the full value of the account once you fully retire. However, your employer may have different models for how you receive the money. Some may pay in a lump sum, while others may offer to pay you over time. This can affect your tax situation enormously when you reach retirement.

Although DROP plans might come across as complex, they’re actually fairly simple to figure out. Suppose you’re ready to retire after working for 30 years as a police officer. Your average salary on the job was $55,000, and your DROP plan comes with a four-year participation limit and a 2% accrual rate.

To calculate what you could earn through your DROP, multiply your average salary ($55,000) by your 2% accrual rate. Then multiply that by the 30 years you worked. That should come out to $33,000. Spread that out over four years and your DROP account could be worth as much as $132,000.

How Defined Benefit Plans and DROPs Differ

Deferred Retirement Option Plans

A defined benefit plan is what most people think of as a pension plan. It is a guarantee from an employer to make payments to the employee for the duration of their retirement. This is as opposed to a defined contribution retirement plan. In this case, an employer guarantees that they will make payments to the employee’s retirement plan during their period of employment.

A typical defined benefit plan calculates benefits based in part on how many years you’ve worked for the employer. Each year you work there, your benefits go up. At retirement age you begin collecting those benefits.

Without modification, then, you can continue to grow your benefits by working past your retirement age. So if you retire at 70 instead of 66 or 67, you’ll collect more in benefits. This is similar to how Social Security works.

A DROP cuts this off. Under a DROP, if you continue to work past retirement age, your employer won’t continue adding to your benefits calculation. Instead, they will take a sum of money and place it into an interest-bearing account. The size of your lump sum and your account’s structure will differ based on the specific plan.

This will continue for as long as you continue to work and qualify for the DROP. Once you fully retire, your benefits plan will begin as normal. You will also receive the full value of the DROP account, including all the interest it accrued while you were working.

Bottom Line

Deferred Retirement Option Plans

Like anything related to retirement, be sure to take into account the pros and cons of all your options prior to making any major decisions. DROP plans clearly offer many perks in exchange for working a little longer. But just because there’s money on the table doesn’t mean that remaining in the workforce is definitely the right choice.

When determining how much money you have for retirement, make sure to also account for your IRAs and 401(k)s. If you’re having trouble keeping all your savings in order, it could be worth working with a financial advisor.

Tips for Your Retirement Plans

  • It can be overwhelming and daunting to build an adequate retirement plan on your own. That’s why many people choose to work with a financial advisor to help with investing and financial planning. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have free introductory calls with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Although most Americans would find it nearly impossible to live off of Social Security alone, it can be a great supplement to your existing retirement assets. Curious about what you can expect to receive in Social Security? Check out SmartAsset’s Social Security calculator.

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