July 1st of 2022 marked the beginning of a new benefit for FRS Investment Plan members. This is the...
DROP Extension for LEO, What Are the Benefits?
As you may be familiar by now, last year HB5007 was passed into law and added the option for special risk class law enforcement officers to extend DROP for up to 3 years after their initial 5 years in DROP. Though this seems like a boon for LEO that would have been caused by a need for departments to try to keep more experienced officers on the force for longer as many departments are facing personnel shortages, there could be another reason.
Is it possible instead that the state actually benefits more from the extended three years of DROP more so than the officer? Here is an example where that may be the case. We will take an officer earning $80,000 annually, at age 47, planning to retire at age 55 who has just reached 25YOS on the force.
The office hears about the extended DROP timeline and enters DROP now for 8 years. At this point, his pension calculation freezes like when any FRS member enters DROP, and his pension amount is locked in at 25YOS x 3% risk class multiplier for a 75% of his $80,000 average annual final compensation for a $60,000 pension (under option 1) in retirement. Additionally, his DROP would be worth about $570,000 when he retires.
For this comparison we will assume the officer invests his DROP funds in retirement in a fixed interest account paying 3% annually, with the goal to distribute the 3% annually as income.
So in Example 1 with 8 years of DROP, the officer will earn $60,000 annually from his pension, plus an additional $17,100 from his investment earnings from DROP for a Total annual income in retirement of $77,100.
Now lets look at option 2, the traditional 5 years of DROP.
In this example, the officer defers entering DROP until age 50, and therefore has 28 YOS before he enters DROP. That means he locks in a pension calculation multiplier of 84%, instead of the 75% from option 1. This takes his pension income up from $60,000 up to $67,200. On the other hand, this reduces his DROP benefit from about $570,000 down to $408,000
So with these numbers in Example 2 we have the same retirement age, but a pension of $67,200 and with the $408,000 from DROP invested the same way as in option 1 he would earn an additional $12,240 in investment income. This takes the total annual income to the officer in option 2 up to $79,440. That is over $2,000 more in annual income, with the same amount of time in service. There is also the additional benefit that the officer is not making the permanent choice of entering DROP for an additional 3 years, in case any of his plans change in those first few years. On the other hand, the first example gives the member more liquidity in retirement than example two.
|Example 1: 8 Years of DROP||Example 2: 5 Years of DROP|
|Income from DROP Funds||$17,100||$12,240|
Now let's look at how this benefits the state of Florida. Let's assume the life expectancy of the officer is to age 85. If the officer is to retire at age 55 in both examples, that means he will receive that benefit for 30 years. In option 1, the state pays a total amount in pension payments of $1,8000,000 In example 2 his total pension payments is $2,016,000. Though the state does pay the member a higher amount in DROP initially, the cost of paying the member a higher pension over the long term, especially if a spousal beneficiary may be considered, could be a driving factor to why the DROP extension was put in place. It is important to note that this is an extension of the primary 5 year DROP window, and only applies to law enforcement officers who enter DROP before July 1st of 2028. Members who enter DROP still enroll for 5 years, and then extend the drop period for the remaining three. This also opens the door for legislative change impacting a member's plans to extend that DROP window should rules change. We aren't saying you should avoid the 8 years of DROP over the previous 5 year allowance, but many factors should be considered when it comes to making permanent decisions in your retirement plan. If you aren't sure what option to choose, you can schedule a complimentary meeting with one of our representatives who will be happy to answer your questions.
This hypothetical examples included within this post are for illustrative purposes only and do not constitute tax, legal or accounting advice. For advice regarding your personal situation, please consult an appropriately licensed professional.