DROP Plans
Deferred Option Retirement Programs (or DROP) plans, first established for Louisiana
firefighters in the mid-1980's, are becoming increasingly popular retirement options
for public safety plans with a relatively early retirement age. We expect that eventually
most public safety plans will include some type of DROP feature, and DROP may also
be used by private sector employers who want to retain their older workers.
What is a DROP?
DROP plans allow public sector employees to continue to work beyond their Normal Retirement
Date and to convert the value of part of their retirement benefits into a lump sum.
This lump sum is traditionally defined as the accumulation of the annuity benefit
that the employee was entitled to receive at Normal Retirement Date. In order to qualify,
though, the employee must give up a portion of his or her annuity.
For example, a firefighter may reach his Normal Retirement Date at age 50 with a benefit
of 50% of his $40,000 salary. In a traditional plan, the employee could choose to
retire with a benefit of $20,000 a year or could continue to work and earn a higher
annuity. Under a DROP plan the $20,000 annuity is frozen, but the employee begins
to accumulate an annual lump sum, based on deposits of the deferred $20,000 annual
annuity plus interest (and in some plans, additional employee contributions). After
three years, the lump sum will accumulate to approximately $80,000.
DROP programs provide substantial lump sum payments in addition to monthly retirement
checks.
Who Benefits?
DROP programs were developed to encourage public safety employees - most often firefighters
and police officers - to continue their careers beyond Normal Retirement Age. The
combination of a large lump sum benefit and the security of an annuity encourages
many employees to select DROP plans, especially those who are not ready to leave the
workforce.
Plan Considerations
There are many variations of DROP plans. The provisions offered can be based not only
on the plan's design, but also on the actuarial assumptions and the plan experience.
Assumptions which make annuities more valuable, like early retirement ages, low interest
assumptions and high salaries, would tend to reduce the cost of the DROP and make
it easier for plan providers to design a cost neutral DROP. Other considerations are:
the length of time an employee can stay in a DROP plan, death and disability benefits,
COLAs and eligibility periods. In addition, just because a DROP plan is cost neutral
for the average employee does not mean that it is cost neutral for all employees;
older employees who are well beyond their Normal Retirement Ages, may generate some
extra costs.
Bolton Partners Experience
Bolton Partners has considerable experience assisting public sector clients
with establishing and managing DROP programs. We have worked with employee groups
throughout the country in the design and negotiation discussions of DROP plans, and
have a special understanding of what it takes to add this option to a plan.
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