Here’s a question we often hear from members: what is the difference between DROP and Deferred Retirement?
Some confusion is definitely understandable. After all, the “D” and “R” in DROP stand for Deferred Retirement. So already, we’re starting from a pretty tough spot.
Both DROP and Deferred Retirement are very popular among members, but for different reasons. And depending on your goals and your financial situation, one of these programs might be a good fit for you.
In this post, we’ll clear up the confusion regarding these two plan features. To start, let’s take a quick step back and define both terms involved.
Deferred Retirement Option Plan (DROP)
The Deferred Retirement Option Plan, as explained in this video, is a way to build a cash account during your final years at your department. When you enter DROP, technically you’ll be retiring on paper. Your monthly lifetime benefit amount will be finalized, and FPPA will begin depositing that pension check into a self-directed account along with your member contributions each paycheck, as you continue to work for up to five more years.
When the DROP period ends, those deposited funds will be available to you as a lump sum. You’ll have various payment options available, but essentially the account is yours to use however you want. You’ll also begin receiving your monthly benefit checks.
DROP is popular with members who want to do things like start a business, settle outstanding debts, or pay off their home. Basically any situation where the freedom of a lump sum cash account is helpful.
Deferred Retirement allows you to delay commencement of your benefit payments for any amount of time between ages 55 and 65. In exchange for delaying your pension, you’ll receive an increase in your benefit amount that grows as you wait. In this case, there is no cash account built up, but your monthly lifetime pension check will be larger.
This option is popular among members who will have a different source of income after they separate from their department, and won’t need to begin collecting their pension benefit right away.
Before you ask, let’s get this out of the way… no, you cannot do both DROP and Deferred Retirement
Due to FPPA rules and plan regulations, it is not possible to take advantage of both of these programs. Sometimes, this reality makes a hard decision even harder. For this reason we recommend running a few scenarios to see how these provisions might benefit your specific situation.
Speaking of which…
Here are a few examples of DROP vs. Deferred Retirement
So, what might DROP and Deferred Retirement benefits actually look like in practice?
To illustrate the differences, let’s look at how these programs might benefit a fictional member named Joe. Joe has 25 years of service and recently became eligible for a normal retirement with FPPA. He is interested in either using DROP for five years to build up a lump sum cash account, or using Deferred Retirement for five years to increase his lifetime monthly benefit.
Joe is 55, has 25 years of service in the Statewide Defined Benefit Plan, and makes $85,000 per year. For the purposes of this calculation, we’ll also say $85,000 is his highest average base salary.
What’s Joe’s monthly benefit?
To calculate Joe’s monthly benefit, we’ll reference the chart on page one of the Statewide Defined Benefit Plan brochure:
Shown above, Joe is eligible for a benefit of 57.5% of his highest average base salary, or $48,875 per year. Broken down monthly, that earns Joe a monthly lifetime pension check of $4,072.92, before applicable taxes.
In other words, if Joe elected to receive a normal retirement benefit—without additional funds from DROP or Deferred Retirement—he would receive $4,072.92 in lifetime pension benefits each month (before taxes) once he retired.
What if Joe entered DROP?
If Joe chose to enter DROP for the maximum five years, as explained above, his monthly benefit and member contributions would be collected in a self-directed account. This includes his $4,072.92 monthly pension check and an average of $807.50 per month in member contributions. Over the five years Joe will continue working, his DROP account could build up to something like this:
In our example, Joe’s account would contain just over $331,000 once he finished five years of DROP. This depends on a few factors, like investment returns and actual time spent in DROP. Joe would also start receiving his monthly benefit of $4,073 once he exits DROP.
What if Joe went with Deferred Retirement?
Rather than building a lump sum, Deferred Retirement allows FPPA members to receive a larger monthly benefit check each month by delaying the start of their payments after separating from their department. Members are eligible to begin this deferral at age 55.
Let’s say Joe plans to stop working for his department at age 55, but continue working for a few years in a different industry. He doesn’t need his pension check right away so he decides to go into Deferred Retirement for five years. To calculate his eventual benefit, we’d start with his monthly benefit as of his Normal Retirement Date of $4072.02. We’d then compare it to the chart on page 3 of the Statewide Defined Benefit Brochure:
Next, we’d calculate Joe’s deferred monthly benefit by multiplying his original monthly benefit by the factor shown on the chart above.
Altogether, going into DROP would result in a projected lump sum of $331,411. But, DROP would not increase Joe’s monthly lifetime benefit. Deferring his retirement would add $2,305 every month to Joe’s lifetime benefit, but wouldn’t generate a lump sum cash account.
Bottom line: which one is better?
In truth, the best option is the one that works for you. It’s a cliché answer, but it’s absolutely true. Depending on your unique situation, DROP, Deferred Retirement or neither might be the right decision.
Our best advice: work with your financial advisor and an FPPA retirement coordinator to determine which option best fits your financial goals.
Do you have questions about DROP or Deferred Retirement? Drop us a line! <–Pun intended!
Ryan Woodhouse is a Digital Content Specialist for the Fire & Police Pension Association of Colorado. When not authoring blog posts, Ryan can be found fly fishing in the Colorado high country or shouting at the TV during University of Wisconsin football and basketball games.