Stop, DROP and Roll
There are many things to consider when you are about to stop working and finally retire. The DROP program adds even more questions to factor into your retirement plan. We are here to help you understand what your options are and help you develop a retirement strategy that is individually tailored to your situation. Here are some questions that we hear on a regular basis: (There are more questions that are not covered here and all of these answers may not pertain to your unique situation, so we would urge you to schedule an appointment with us to review your concerns on a one on one basis.)
What is the DROP program?
The DROP program stands for Deferred Retirement Option Plan. It is a program that was designed to keep firefighters from retiring too early and putting a strain on the city to hire and train new firefighters. (This is currently available for Los Angeles City Fire Department and a few others throughout the country.) When you enter the DROP program, you cease to accumulate length of service years toward your pension. You have actually “retired” and started drawing your pension. You continue to work and are paid your salary and overtime, but you are also paid your pension every month which is set aside in a separate account. This is known as your DROP account. While in DROP, your monthly pension payment is held with a guaranteed interest rate of 5% annually. You can stay in the program for up to 5 years, but then at that point you must retire officially.
When should I enter DROP?
There are many things to consider when answering this question. Do you plan to promote soon or are you at the highest pay scale you plan to achieve? If you are promoting soon, you may want to wait to lock in that higher pension amount because of the increase in your base salary. Will you be financially ready to retire in 5 years? Are there debts that need to be tackled first? Do we need to worry about education costs for children before retiring? These are important financial issues to get a grip on before entering the DROP program. Will you be emotionally ready to retire in 5 years? Some people are not ready to make this commitment. Once you choose to enter the DROP program, you will not be able to work more than 5 years longer. Some people ask whether to work 2 more years and do 3 years in DROP or should they just enter DROP now for 5 years. We can work with you and look at all the combinations and help you determine what makes the most sense for you and your family.
What do I do with the DROP account when I leave?
Since you cannot leave the money in the DROP account, you basically have three options. You can take a lump sum distribution, roll the money into your deferred compensation plan (457) or you can roll the money into a Rollover IRA. With the lump sum distribution, the entire amount will count as income that year and you will pay income taxes on the entire amount. This is very important to consider because of the large amounts of money in the DROP account. This can lead to a significant tax hit. If you roll the money over into deferred compensation or an IRA, you can continue to defer the taxes and invest the funds. Whether you use your deferred compensation plan or an IRA will depend on several things; including your age, how much flexibility you want with your investments, professional management and the actual types of investments you wish to invest in.
What investments should I choose in my Rollover IRA for my DROP money?
This is a question that is unique for each and every one of you. Some people want to supplement their pension and invest in conservative products to limit the potential for market-related issues. Others are interested in potentially greater risk/return. Through CUSO Financial Services, LP (CFS), we provide a variety of non-deposit investment choices including brokerage CDs, US Treasury bonds, corporate bonds, mutual funds, stocks, fixed annuities, index annuities, and variable annuities. Please make an appointment with us to review your situation and create an overall financial plan that fits your goals and risk tolerance.
When should I come see you?
You should come in and see us as early as possible in the retirement planning process. We can help you determine whether it’s wise to enter the DROP program or wait. We can help discuss what your options are when you exit the DROP program, so that you can have confidence in knowing how your DROP money can work best for you. At the very least, you should come in to see us a few months before you retire, so that we can help with your exit paperwork and establish a Rollover IRA, if needed.
For assistance, please contact Jason Torrey-Payne, CFP®.
Jason Torrey-Payne, CFP®
CUSO Financial Services, L.P.
CA Insurance License #0D56535
(800) 231-1626, Ext-2269