After decades of answering the call, many firefighters are eager to retire. Following 25 or 30 years of dedicated service, the dream of relaxing and enjoying a well-earned break is highly appealing. However, after reviewing your retirement plan with a financial advisor, you might be surprised to find that you’re not quite ready to hang up the helmet – at least financially.
This is where a DROP plan can come in handy. You may be familiar with the term, but perhaps you’ve never looked into it, focusing instead on the prospect of an early retirement. Now might be an excellent time to examine a DROP plan and see how (or if) it could improve your retirement readiness.
What is a DROP Plan?
DROP stands for Deferred Retirement Option Plan. It is a way for public institutions to retain top talent in public institutions, such as fire departments, police departments, and school districts, while improving the retirement readiness of those who opt into it. When you’re eligible to retire, you instead ‘defer’ your retirement voluntarily.
Basically, you ‘retire’ on paper but actually continue to work. Upon entering the DROP plan, your pension is calculated based on your salary at that time, but any future raises or promotions you receive while participating in the DROP plan will not increase your pension amount. While your take-home pay may increase due to career advancements, the pension you accumulate in the DROP plan remains fixed based on the salary you were earning when you first joined the program.
Instead, your pension payments are placed into a separate account and accumulate a usually predetermined interest rate while you continue to earn a salary. Once you actually retire, you receive your original pension amount PLUS the accumulated funds from the DROP account.
Why enroll in a DROP plan?
Maybe you love your job and can’t imagine quitting yet, or perhaps you feel a strong sense of public duty. In all likelihood, though, the answer is probably money. Retirement is expensive, and your firefighter pension alone may not be up to the task.
Your DROP plan could potentially add hundreds of thousands of dollars to your retirement fund and give you greater financial flexibility when you finally do retire. Moreover, by participating in a DROP plan, you’re essentially earning two incomes simultaneously – your regular salary and your accumulating pension – allowing you to bolster your savings substantially during these final years of service and improving your chances of an improved lifestyle in retirement.
What are the eligibility requirements for a DROP plan?
DROP eligibility requirements vary from state to state and municipality to municipality; unfortunately, not all states or cities offer them. However, there are some general requirements that many DROP plans share when they are offered:
Years of Service: Typically, eligibility for a DROP plan is contingent on having completed a minimum number of years in service. This duration varies but often ranges from 20 to 25 years.
Age Requirements: Most DROP plans require participants to be of a certain age, usually in their late 40s or early 50s, to qualify.
Employment Status: Eligibility for a DROP plan generally requires that you are an active, full-time employee in a qualifying position, such as a firefighter, police officer, or other public servant.
Retirement Eligibility: Firefighters must usually be eligible for normal retirement benefits under their existing pension plan to opt into a DROP program.
No Prior Participation: Some DROP plans stipulate that participants must not have previously enrolled in the DROP or a similar deferred retirement option.
Should you enroll in a DROP plan?
You may want to consider enrolling in a DROP plan if:
- Your pension benefits are already maxed out.
- You want to lock in your current pension benefit in case calculations change.
- A DROP plan would bring in more savings than continuing with your regular pension.
As for that last point, you can determine your benefits through your state’s or city’s pension page for retirees or by consulting a financial advisor.
You may want to hold off on a DROP plan if you don’t feel you’ll be ready to retire at the end of your DROP enrollment period or if you can foresee a promotion that would bring a considerable raise.
DROP Plan Distribution & Taxation
DROP distributions are taxed as ordinary income. Once you have retired and completed your DROP plan, you have a few options in most cases. Common options include a) receiving a lump sum, b) receiving payments, or c) receiving a lump sum as a percentage of your proceeds and receiving payments for the remainder. Your actual options will depend on your plan’s rules and regulations.
Be advised, though, that a lump sum may have negative consequences on your tax plan – it may bump you up a tax bracket and affect other aspects of your financial plan. While it may sound enticing to take a lump sum to pay off a mortgage or other debt heading into retirement, a careful analysis of your overall financial and tax situation should be conducted before deciding on the optimal path of your DROP savings.
The Drawbacks of a DROP Plan
- While every DROP plan is different, most are based on a three to five-year period – meaning you can’t let your funds grow indefinitely. In fact, you may be forced into ‘real’ retirement after your eligibility period is up.
- Interest rates vary widely between DROP plans, so the interest rate you receive may be disappointing. On the other hand, it is typically a guaranteed interest rate.
- As mentioned before, participants may not clearly understand the tax implications of DROP distributions and accidentally increase their taxable income by damaging amounts.
Unfortunately, many Americans make the mistake of retiring early and unprepared, and firefighters are no different. It’s natural to want to retire as soon as possible – firefighting is dangerous, hard on your body, and often thankless. But retiring before fully understanding your long-term financial situation could undo all those years of service and sacrifice.
If you are unsure of your retirement, the DROP plan may be the missing piece in your strategy, but it shouldn’t be decided on alone. From taxation concerns to accrual rates and numerous other analyses, things can quickly get complicated.
If you’re interested in how the DROP Plan or other retirement strategies could benefit you, Protection Red is here to help. Reach out to us for a personalized consultation, and let’s work together to craft a retirement plan that supports your goals and honors your years of dedicated service.
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