Retirement Planning for Law Enforcement Officers –Navigating Deferred Retirement Option Plans and Partial Lump-Sum Option Payments

As you near retirement as a law enforcement officer, you may begin to worry about your future financial security. Stress, burnout, a career change, medical issues and the challenges of navigating a pension may be weighing heavily on your mind.

One particular challenge you may face is navigating the decisions related to deferred retirement option plans (DROPs) and partial lump-sum option plans (PLOPs). Your decisions related to these programs can have a significant impact on your pension income, as well as on your tax planning, investment strategy, retirement timeframe, estate planning and more.

You may be wondering:

• Should I enter the DROP?

• Should I exercise the PLOP?

• How should I manage my lump-sum earnings?

While the answers to these questions depend on your goals and personal financial situation, there are some important considerations to keep in mind as you navigate these decisions.

How DROPs and PLOPs Work

The first step in maximizing your DROP and PLOP elections is to gain a thorough understanding of how they work.

What is a DROP?

If offered by your local employer or through a state pension system, a deferred retirement option plan (DROP) can allow you to continue working and earning a salary if you meet certain years of service and age requirements. If you choose this option, employer contributions are routed to your DROP account instead of your pension, but you don’t lose any value in your monthly annuity once you retire and begin collecting pension payments.

Key DROP considerations:

The following considerations can help you determine whether a DROP makes sense for you:

• DROP terms –DROP terms are typically three to five years long. If you choose to leave prior to the end of the term, the value of your DROP may change.

• Tax implications – If you receive a lump-sum payout of your DROP when you retire, you’ll be subject to ordinary income tax, and the distribution has the potential to push you into a higher income tax bracket. To avoid this tax exposure, you may decide to complete a direct rollover to a qualified retirement plan, such as a 401(k) or IRA.

• Irrevocable decision – One you enter a DROP, you’re typically locked into the financial termination date. This means you must be prepared to leave your job at the end of the DROP period.

• Alternative benefit status – When you enter a DROP, you’ll likely be considered “retired” for pension purposes. However, you may still be viewed as an active employee when determining your eligibility for employer-sponsored benefits, such as health and disability insurance, worker’s compensation, etc.

• Lack of investment control – Once you enter a DROP, your contributions are routed to your DROP account instead of your pension. While you continue working, your DROP assets are deposited into a pooled trust, where they’re managed by a board of trustees. This means you have no say in how the funds are managed or invested. Once you’ve retired, you can roll over the funds to a qualified retirement account and choose how to invest the assets.

What is a PLOP?

A partial lump-sum option plan (PLOP) allows you to receive a portion of your pension as a one-time payment that’s calculated based on an actuarial equivalent of a percentage of your total pension benefit. Your monthly benefit amount is then permanently reduced to account for the value of the lump-sum payment.

Here’s how it works:

• When you apply for your pension at retirement, you elect to receive a percentage of your total pension benefit as a single, lump-sum payment.

• Your monthly benefit payments are recalculated to account for the lump-sum distribution.

• Once you elect a PLOP, you can’t change your mind.

Strategic Considerations for Your Election

Before electing either a DROP or a PLOP, it’s absolutely vital to work with your wealth manager to conduct a comprehensive analysis of your financial life and retirement planning strategies. Your elections should be guided by your goals, timeline, financial challenges and legacy wishes.

Analyze your income needs and liquidity

For example, if you’re hoping to maximize your monthly income in retirement, it may not make sense to take a PLOP. On the other hand, if you face a significant expense at the onset of retirement, such as paying off a mortgage, a PLOP may be able to help you with that.

It’s also important to consider your other sources of retirement savings. If you have additional accounts to draw from, such as a 457(b), a 401(a), an IRA or brokerage accounts, you may have added flexibility to receive a distribution from a DROP or PLOP.

Manage your tax exposure

Keep in mind that a large lump-sum payout from a DROP or PLOP has the potential to push you into a higher income tax bracket. This means your decision of whether to take direct possession of the funds or roll them into a qualified retirement account can greatly impact your overall tax exposure and long-term income strategy.

Before making a decision, be sure to consult with your wealth manager and tax advisor who can help implement tax planning strategies to minimize your liabilities.

Consider your legacy wishes

Your DROP and PLOP distributions can also greatly impact the amount you have available to leave as a financial legacy for your loved ones. Rolling over funds into a qualified retirement account can help preserve the tax-deferred growth of your assets and provide you with additional estate planning flexibility. In contrast, taking a direct distribution can result in significant tax exposure and reduce your long-term wealth-building potential, resulting in fewer assets available to pass along to your heirs.

However, pensions often allow for only a spousal beneficiary. This means benefits end when your spouse passes away, and no lasting legacy is available to support additional generations of family members.

If your goals include providing lasting financial support for future generations, it’s important to work with an estate planning attorney who can help you make smart decisions and ensure your assets pass according to your wishes.

Plan for various scenarios

Before making DROP and PLOP elections, it’s important to understand their potential impact on your lifetime income stream, healthcare affordability, investment longevity and more. Using advanced planning software, your wealth manager can model different scenarios to help you determine the feasibility of achieving your financial goals under various conditions. By making adjustments to your benefit elections, time horizon, lifestyle, monthly spending, potential emergency expenses, etc., you can stress test your potential financial outcomes and see how your DROP and PLOP elections may impact those outcomes.

Maximize the Opportunity

It’s important to ensure the assets you receive as a DROP or PLOP are invested in a manner that aligns with your long-term goals and complements your overall investment portfolio. It may also make sense to invest a portion of your ongoing pension annuity into an after-tax brokerage account with a focus on compounding growth beyond your pension.

Your wealth manager can help you make smart decisions to optimize your long-term returns and wealth-building potential.

Bottom Line

DROPs and PLOPs are critical levers in your overall financial strategy, but to get the most out of them, it’s vital that they align with your overall financial plan. A qualified wealth manager can help ensure these benefits work efficiently with your investments, taxes, retirement timeline and estate planning strategies. With the right strategies in place, you can make your years of dedicated service to the police force translate into lasting financial confidence, flexibility and control throughout retirement.

For help navigating your DROP and PROP options, schedule a call with a member of our law enforcement advisory team. We look forward to getting to know you.