How Does the Los Angeles Deferred Retirement Option Plan (DROP) Work?
By Scott Rojas, CFP®, MBA
If you’re an eligible employee, you can take advantage of L.A.'s Deferred Retirement Option Plan (DROP). An enhancement to the L.A. Fire and Police Pension (LAFPP), the DROP is an optional and voluntary retirement savings program for eligible fire (LAFD), police (LAPD), harbor, and airport employees.
With the DROP, you can continue to earn a salary and turn on your pension in the final years of your employment, for up to five years. The pension funds deposited into the DROP account earn 5% per year. Once the five-year period is complete, you retire, and the DROP funds can be moved tax-free into a retirement account, if you desire.
To become eligible for DROP, you need:
To have 25 years of service and be a Tier 2 or Tier 4 employee; or,
To have at least 25 years of service; be a Tier 3, Tier 4, or Tier 6 employee; and be at least 50 years old.
Once you leave the DROP, you can take a lump sum cash payment, roll over the balance to a retirement account, or opt for a combination of a lump sum cash payment and a rollover.
The lump sum cash payment is taxed as taxable income and likely generates a large tax bill. A rollover to a retirement account would be a tax-free transfer and taxable only as the funds are withdrawn from the account. The federal government will require you to begin withdrawing funds from the account the year you turn 70 ½.
Other Retirement Considerations
DROP funds are often used to supplement and enhance retirement income. As you consider utilizing the DROP program, here are other retirement-related items you should consider:
Pension plan survivorship options: The LAFPP offers many survivor benefit options. Your decision should factor in your investment accounts, Social Security benefits, and other revenue sources. Think about the long-term implications of this decision. If you’re married, we recommend the highest survivor benefit option allowed. This option helps protect the survivor if something happens to the pensioner.
Long-term care insurance: Costs for long-term care have the potential to consume a large portion of your retirement income. While it can be costly to cover 100% of these expenses out of pocket, a long-term care policy is one way to manage them. For a healthy couple in their early 60s, a long-term care policy generally costs between $6,000 and $7,000 per year.
Inflation: Think about inflation and how it can impact both your investment portfolio and purchasing power over time. For 2019, the cost-of-living adjustment (COLA) is at 2.5%.
Estate planning: Make sure your beneficiaries are current, and consider working with an attorney to draw up a will or trust agreement.
Debt: Develop a plan to pay off your home and other debt as you enter retirement. Paying off debt can give you more flexibility to enjoy retirement.
Think long term: It is not uncommon for our Fullerton financial planning firm to run retirement projections for our clients to age 95. Americans' increasing longevity makes it critical to develop a spending plan that understands the impact of inflation over time. The plan should include Social Security income, investment portfolio returns, and other income sources.
Taxes: California is a high-tax state. Make sure you plan for this and understand how your various assets will be taxed. If you are not withdrawing funds from your retirement plan in your 60s, if may make sense to convert some of your retirement funds to a Roth IRA if your required minimum distribution (RMD) pushes you into a new tax bracket.
Rollover options: We suggest you look for a discount broker or consider using an investment advisor to manage the funds. If managed properly, these funds can be used to supplement retirement income.
Schedule a 15-minute discovery call with a fee-only financial advisor to discuss your personal situation.