The Deferred Retirement Option Plan is a pension feature that is available to employees who have at least twenty-five years of service and are retiring with an unreduced (normal) pension benefit. The DROP is not available to those who retire early, are on a disability pension, or who are receiving a survivor benefit.
How does it work?
When you retire, you will be given the option to request a DROP payment equal to one, two, or three years' worth of your monthly pension payment (the actual calculation will depend on your life expectancy and other factors). Metro will subtract the amount of the lump-sum payment from your lifetime pension benefit, which will permanently reduce your monthly pension payments. In other words: the total value of your pension benefit over your life expectancy will remain the same, but your monthly benefit will be reduced because you elected to take part of the total value up-front.
If you elect the DROP, you have the same pension plan options as retirees who did not qualify for the DROP. Any payments available to you or your beneficiary (if you choose to designate one) will be reduced to reflect the amount of the DROP lump sum, but, again, the total value of your pension will be the same, regardless of whether you elect the DROP or not.
Your Social Security benefits will not be affected by electing the DROP. Your annual cost of living increases (COLAs) are based on your initial monthly benefit; therefore, by electing the DROP, your cost of living allowance will be based on a lower benefit.
How will I receive my payment?
There are a few different ways you can opt to receive your DROP lump-sum payment.
First, you can request that the entire DROP amount be paid directly to you. If you elect this payment option, taxes will be withheld before you receive the check, and the entire amount will be considered as part of your income for the year in which you receive the payment.
Another option available is to roll the entire DROP over to your 457 Deferred Compensation Plan, IRA, or other qualified plan. Taxes may be deferred if you roll over the lump-sum payment to a qualified plan.
The third option is to roll part of the DROP into one of the qualified plans referenced above and have the remainder of the lump-sum payment paid directly to you. Taxes may then be deferred on the amount that you roll over into a qualified plan.
How do taxes affect the DROP?
The IRS requires that Metro withhold 20% in Federal Income taxes from the amount of the DROP lump-sum payment. The 20% is not a tax in and of itself - it is an amount withheld to be applied to your taxes. When you file your taxes for the year, you may receive a refund of part of this amount or you may owe more, depending on your particular situation.
Should I take the DROP?
That is really a question only you can answer, and there are many important things you should consider when determining whether this option is the best one for you. There may be tax ramifications involved if you take the lump-sum payable directly to yourself, and there may be limitations and penalties involved if you roll the funds into a 457, IRA, or other qualified account. Regardless of how you elect to have the DROP paid to you, simply accepting it will lower your monthly benefit, and that is something that you must plan for, as well.
Please consult a tax adviser, financial planner, lawyer - whomever you trust to give you the best guidance for your financial situation. Consider both the short-term and long-term consequences of choosing this option, as once the DROP has been elected, it cannot be reversed.