Reasons To Consider Not Entering DROP Immediately

For many Florida Retirement System members, reaching DROP eligibility feels like a finish line, but eligibility does not necessarily mean that entering DROP immediately is the best financial decision. That can be especially true for Special Risk members who recently received a substantial salary increase.

Once you enter DROP, your pension is calculated using your service credit and Average Final Compensation at that time. Salary earned while participating in DROP does not add service credit or increase the pension calculation. The decision therefore comes down to a tradeoff:

• Begin accumulating DROP payments sooner; or
• Continue earning service credit while allowing higher-paying years to replace lower-paying years in your AFC.

Sometimes the second option produces a substantially larger lifetime pension.

Let's Look At A Comparison

Assume the employee:

• Is age 50
• Has 25 years of Special Risk service (3% multiplier)
• Earned approximately $90,000 for many years
• Received a raise to $125,000 three years ago
• Plans to stop working at age 55 either way
• Uses the Option 1 pension amount
• Earns a hypothetical 6% effective annual return on the DROP balance
• Receives no additional raises

We will exclude COLAs, taxes, employee contributions, leave payouts, and survivor-option reductions so we can isolate the effect of the higher AFC and additional service. 

Option 1: Enter DROP immediately at 25 years

At age 50, the employee’s five-year AFC includes three years at $125,000 and two years at $90,000:

(3 x $125,000) + (2 x $90,000) = $111,000

With 25 years of Special Risk service, the pension multiplier is:

25 x 3%  = 75%

That produces the following Option 1 pension:

$111,000 x 0.75 = $83,250

The employee’s initial benefit would therefore be:

• Annual pension: $83,250
• Monthly pension: $6,937.50

Those monthly payments would accumulate in DROP for five years. Assuming monthly deposits and DROP's 4% effective fixed annual return, the DROP balance at age 55 would be approximately (excluding COLA increases and rounded down): $450,000

The employee would then leave employment at age 55 with the DROP balance and begin receiving the $83,250 annual pension directly. 

Option 2: Wait two years before entering DROP

Now assume the employee continues as an active FRS member from age 50 to age 52.

By waiting, two important things happen.

First, the two remaining $90,000 years roll out of the five-year AFC calculation. The employee now has five complete years at $125,000:

AFC= $125,000

Second, the employee earns two more years of Special Risk service:

27 x 3% = 81%

Notice that this is an increase of six percentage points in the pension multiplier from 75% to 81%.

The new pension calculation becomes:

$125,000 x 0.81 = $101,250

The employee’s benefit at age 52 would be:

• Annual pension: $101,250
• Monthly pension: $8,437.50

Because the employee still plans to leave at age 55, only three years of payments accumulate in DROP. At the same hypothetical 4% return, the resulting DROP balance would be approximately (excluding COLA and rounded down): $315,000

The side-by-side result

How do the Numbers Stack up in Monthly Income?

To calculate this, let's assume that the member would invest their DROP money the same way, regardless of the balance, and that those investments would earn a hypothetical average annualized return of 6%. This 6% would be distributed as income to supplement the pension each year.

In Option 1: The member has a $6,937.50 monthly pension, plus ($450,000 x 0.06 = $27,000/12 = $2,250 per month) $2,250 per month from DROP.

This creates a total monthly income of: $9,187.50 ($110,250 annually)

In Option 2: The member has a $8,437.50 monthly pension, plus ($315,000 x 0.06 = $18,900/12 = $1,575 per month) $1,575 per month from DROP.

This creates a total monthly income of: $10,012.50 ($120,150 annually)

This hypothetical example could potentially create an increase to income of $825 per month based on the above factors and assumptions.

The examples in this article are hypothetical and for illustrative purposes only. They assume a steady 6% annual rate of return, which does not represent the return on any actual investment and cannot be guaranteed. Moreover, the examples do not take into account fees and taxes, which would have lowered the final results.

The Real Lesson

DROP is valuable, but entering as soon as possible is not automatically optimal.

Someone should look especially carefully at delaying DROP when:

• They recently received a large raise
• Lower-paying years remain in their AFC calculation
• Additional service earns a valuable multiplier
• They expect to remain employed until the same target separation date
• They value higher guaranteed lifetime income
• They expect a long retirement

Entering immediately may still make sense for someone who prioritizes the larger upfront balance, has health or longevity concerns, does not expect further AFC improvement, or is uncertain whether they can or want to remain employed.

A Few Other Important Considerations

This example only goes over how the AFC and multiplier changes impact DROP and income in retirement, but there are MANY other factors to consider like:

• Selling back sick/leave/vacation time before joining DROP

• Your beneficiary priorities (which pension option and how much beneficiaries receive in DROP)
• Your COLA (and this formula has recently been updated for special risk members)
• Raises during DROP
• Etc.

In order to evaluate your specific circumstance, you can schedule a meeting with a member of our team at Florida Retirement Resources. We help FRS member's like you evaluate your plan benefits and options, and help you build a retirement plan around your retirement goals and objectives. You can schedule a complimentary meeting with a member of our team by clicking HERE.