Chances are, if you’ve attended an HR-sponsored discussion about retirement benefits at your agency, you’ve heard the term DROP before. DROP stands for Deferred Retirement Option Plan, one of the numerous and often confusing benefits typically provided to law enforcement officers in retirement.
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A DROP works as follows: You declare you are “retired” while you are still working, and you receive your pension benefits in a retirement account in addition to your normal income. Usually, DROP is only available during the final 2-3 years before your intended retirement date. The exact structure varies by municipality, but that’s the basic concept.
The idea behind a DROP is that you can begin collecting pension benefits before you leave the job. Those benefits accumulate in a separate account while you continue earning your regular paycheck. The tradeoff is that locking in your pension benefit early could result in a lower monthly pension than if you waited until your actual retirement date.
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DROPs are certainly attractive. The opportunity to build a substantial nest egg during the final years of your career can put you in a strong position for retirement and provide greater flexibility once you leave the job. Whether that benefit outweighs the potential impact on your pension depends on the details of your plan and your long-term financial goals. Here are some key factors to consider when deciding whether a DROP is right for you.
Understand how your pension benefit is structured
The first thing to consider is how your pension benefits scheme works. Let’s say you’ve served 19 years on the job. Some pension programs operate so that, if you retire after 20 years of service, you receive a boost in your retirement income. In that case, we would typically advise not taking the DROP at 19 years and instead taking the higher retirement income benefit. Because you receive pension benefits until you pass away, or they may outlive you if you add your spouse to your pension, we typically prioritize the addition to your yearly income in this situation.
Know how your pension income is calculated
Another thing to consider is how your pension income is calculated. Most programs operate by paying a percentage of your pre-retirement income as your pension. But what they consider to be your “pre-retirement income” can drastically shape your pension payment.
In our experience working with law enforcement, we find that most people have their highest-earning years in the years immediately preceding retirement. Yearly salary increases, seniority benefits and overtime typically mean that their last few years are their most lucrative.
If your retirement program calculates your pension benefit based on your highest-compensated years, it’s important to think about your earning potential before selecting the DROP. Do you think you’ve maxed out your income, or is there still a possibility of promotion and higher overtime in the near future? These considerations need to be weighed before selecting a DROP and potentially locking yourself into a lower retirement benefit.
Review your investment options
Every plan is different, and it’s important to vet your individual options. In some cases, we’ve found that certain accounts can act as a high-yield savings account, with fixed rates of 3%-4%. While that may be good for a savings account, in this economic environment, clients can usually find better growth by participating more in the market. With inflation standing well above 3% as of this writing, it’s important that your money at least outpace inflationary pressures.
If you have more freedom in controlling your DROP contributions, it can be an exciting way to capture some of the growth of the market. But if your investment options are limited, DROP options may become less attractive.
Get guidance before making the decision
Pension plans can be incredibly complicated, but usually, that complexity is a good thing. Law enforcement is difficult work, and governments and unions have come together to ensure that your hard work and sacrifice are valued long after you leave the job.
A DROP is a unique opportunity to use your pension plan to accelerate your retirement savings, providing a useful boost in your ability to put away money to promote future growth. However, the fine print of your retirement plan, including how your income and benefits are calculated and what you can do with your DROP contributions, can drastically change the calculus of this decision.
Because these situations are so complicated, advice from a trusted financial professional can help you make the right choice based on your personal needs and the complexities of your pension plan. It is also worth contacting your pension support team to better understand the specifics of your DROP and how it compares with other retirement strategies.
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