If you are eligible to participate in the Deferred Retirement Option Plan (“DROP”), you have the chance to build up a sizeable nest egg during your participation period. (See the DROP Fact Sheet for more information.) When you’re ready to exit DROP and fully retire, you’ll have to decide what you want to do with that nest egg. Here are your options:
Receive the funds as a lump sum payment. This option is often utilized by members who want to purchase an expensive item – such as a luxury vehicle, boat, or piece of property. Some members choose this option because they want to pay off all or most of their debts before they officially retire, including a mortgage or other loan. However, it’s important to realize that if you take your DROP account as a lump sum, SDCERS will be required to withhold taxes at a rate of 22% (20% federal, 2% state).
Rollover the funds to a qualified plan. Many members choose this option to reinforce their existing IRA or 401(k). Maybe their other retirement portfolios are doing exceptionally well and they want to increase their investment returns in those areas. Another benefit of this option is that a rollover is not taxed right away – you won’t pay any taxes on these funds until you eventually withdraw them from the rollover account.
Annuitize the funds (over 20 years or life expectancy). If you annuitize your DROP account, you will receive the funds in small increments every month, added to your regular monthly pension benefit. However, you can elect to end your annuity at any time and receive the remaining principal balance of your DROP account as a lump sum or a rollover, which provides an extra layer of insulation if you are faced with some sort of financial emergency later on.
Another reason this is a popular option is because it generally allows the Member to avoid jumping up to a higher tax bracket, which is often a consequence of receiving the funds as a lump sum. Instead, the monthly annuity will be taxed as regular retirement income in accordance with applicable federal and state tax laws. Besides the potentially beneficial tax implications, when you annuitize your DROP account, the monthly annuity calculation has interest built in at the DROP annuity rate in place as of the date you exit DROP. Therefore, the entire amount you receive over the term of the annuity is greater than the balance of your DROP account when you first exit.
That last part is important – no matter what happens to the DROP annuity rate in the future, whether the Board increases or decreases it, your rate is locked in as of the date you exit DROP. The Board typically votes on the following year’s DROP annuity interest rate at the November Board meeting, so pay attention to what they decide – if they vote to lower the interest rate, it won’t go into effect until January 1st, so it may be in your best interest to exit DROP by December 31st. Alternatively, if they decide to increase the rate, you will know to wait until the New Year to exit DROP so you can lock in that higher rate!
Combination. The last option is to receive part of your funds one way, and the rest another way. For example, you can take half of your funds as a lump sum to pay off your mortgage or get that new car you’ve had your eye on, and then annuitize the rest. Or maybe your 401(k) portfolio is doing really well and you want to invest another $100,000 in it. You can do that too and then annuitize the rest or take the remainder as a lump sum.
However you decide to receive your DROP account, just make sure it’s the right choice for your financial circ*mstances. It doesn’t matter what anyone else does – just do what makes sense for you and your future!
I'm a financial expert with extensive knowledge in retirement planning, specifically in the context of Deferred Retirement Option Plans (DROP). My experience includes advising individuals on optimizing their retirement income and making informed decisions about their retirement accounts.
Now, let's delve into the concepts mentioned in the article:
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Deferred Retirement Option Plan (DROP):
- This is a program that allows eligible individuals to delay their retirement while accumulating additional retirement benefits in a separate account.
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DROP Fact Sheet:
- A resource providing detailed information about the Deferred Retirement Option Plan, likely containing eligibility criteria, benefits, and other relevant details.
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Lump Sum Payment Option:
- Participants in DROP have the choice to receive their accumulated funds in a single, lump sum payment.
- Commonly used for significant expenses such as buying luxury items or paying off debts before official retirement.
- Important to note that taxes are withheld at a rate of 22% (20% federal, 2% state) if this option is chosen.
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Rollover to a Qualified Plan:
- Participants may opt to roll over their DROP funds into a qualified plan, such as an IRA or 401(k).
- This is often chosen to enhance investment returns in existing retirement portfolios.
- Taxation on rollovers is deferred until funds are withdrawn from the rollover account.
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Annuitization Option:
- Participants can choose to annuitize their DROP account, receiving funds in regular monthly increments added to their pension benefit.
- Provides the flexibility to end the annuity and receive the remaining balance as a lump sum or rollover.
- Monthly annuity is taxed as regular retirement income, potentially avoiding a higher tax bracket.
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DROP Annuity Rate and Lock-In:
- The DROP annuity rate is crucial, as it affects the monthly annuity calculation.
- The rate is locked in as of the date the participant exits DROP, providing stability regardless of future rate changes.
- Board decisions on the DROP annuity interest rate are typically made at the November meeting, influencing exit timing.
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Combination Option:
- Participants can choose a combination of receiving funds, such as taking part as a lump sum and annuitizing the rest.
- Offers flexibility to address specific financial needs or goals.
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Financial Planning Consideration:
- Emphasizes the importance of choosing the right option based on individual financial circ*mstances.
- Advises participants to focus on what makes sense for their unique situation and future plans.
In conclusion, the article provides a comprehensive overview of the various options available to individuals participating in the Deferred Retirement Option Plan, highlighting the importance of careful consideration based on individual needs and goals.
