A Deferred Retirement Option Plan, or DROP, lets you retire on paper while you keep working. Your pension is calculated on the day you enter. For the next few years, instead of paying it to you, the plan deposits it into an account in your name. When you leave work for good, you take that account as a lump sum or roll it over, and your monthly pension starts.
Who offers DROP
DROP is most common in police and fire plans and in some statewide systems in the South. Florida FRS has one of the best known. Louisiana, Arkansas and Oklahoma systems, and many city police and fire funds such as those in Houston, Dallas, Philadelphia and Los Angeles, also offer versions. Most large teacher plans, including CalSTRS, NYSTRS and Illinois TRS, do not.
What you get
During the DROP period you keep your salary and add your monthly pension to the DROP account each month. Many plans credit interest, either at a fixed rate set in law or at a rate tied to the fund’s earnings. Some also add your cost-of-living increases to the deposits. After five years, a $3,000 monthly pension becomes a lump sum of about $180,000 before interest.
Some plans also stop your pension contributions while you are in DROP, which raises your take-home pay.
What you give up
Your pension is frozen at entry. The years you work during DROP add no service credit, and raises during DROP do not lift your final average salary. If you had simply kept working the same five years without DROP, your pension would have grown. With a 2% multiplier, five more years add 10% of salary to the formula, and any raises add more.
That smaller monthly check lasts for life, and it is usually what a survivor option is based on too. So DROP trades a permanent cut in monthly income for a large lump sum now.
When DROP tends to win
- The interest credit is generous or tied to strong fund returns.
- Your multiplier is low, so extra years would add little.
- Your salary has stopped rising, or you are already at a benefit cap.
- You expect a shorter retirement or want cash for a specific goal, such as paying off a mortgage.
When working on tends to win
- Your plan’s multiplier or age factor rises with longer service or older age.
- You expect a long retirement or want the largest survivor benefit for a spouse.
- The DROP interest rate is low or zero.
The rules that trip people up
You must leave on time. DROP periods have a fixed maximum, often five years, sometimes up to eight. You must separate from employment by the end, and staying past it can cost you the account or trigger penalties.
Leaving early is allowed. You can usually end DROP early, but you cannot undo it and go back to earning service credit.
Taxes. The lump sum is taxable as ordinary income if you take it in cash. Rolling it into an IRA or a 457(b) defers the tax.
Death during DROP. Plans differ on what a beneficiary receives if you die while in DROP. Read this section of the rules before you enter.
Running the numbers
The DROP calculator compares the two paths using your pension today, the extra monthly amount each additional year would add, the DROP interest rate and how long you expect retirement to last. It shows the age where the bigger pension catches up with the lump sum. If that age is beyond your plans, DROP likely comes out ahead.