The word retirement is being seen in an entirely new light off late. Some people are retiring early in their 40s under the Financial Independence Retire Early (FIRE) movement. And others are unwilling to retire even in their 60s. There is no fixed rule to retirement anymore and employees have the freedom to choose when they get to begin the golden years of their life.
Moreover, while retirement is commonly referred to as the golden years, it may not necessarily hold the same connotation for everyone. A lot of people find the transition to retirement hard. This is why they continue to work beyond their retirement years. Working beyond retirement can be beneficial for a number of reasons. You can continue earning an income and hence enjoy better financial security in your old age. You also stay busy and productive that leaves a positive impact on your mind and overall health. Social and professional interactions and friendships also add value to your life. However, your retirement account contributions and distributions may end up being a little tricky to manage if you continue to work beyond the retirement age. Your taxability can be impacted and you may no longer be able to contribute to a defined benefit plan after maxing out your contributions. Deferred Retirement Options Plans can be a suitable way out here.
Deferred Retirement Options Plans (DROPs) are the perfect answer for public sector employees who wish to continue working past the official retirement age. These plans can benefit the employee as well as the employer with numerous advantages. To know more about DROPs, consult with a professional financial advisor who can explain if the retirement strategy is useful for your financial needs. Keep reading to find out more DROP retirement plans and how they can be used.
DROP retirement plans were introduced in the 1980s. The DROP program enables an employee to keep working even though they may have reached the retirement age. Typically, when an employee works, their working years are added to their years of service. This, in turn, increases their pension benefit amount. However, in the case of the DROP program, the employer puts a lump sum amount in a separate account for every year the employee works. This account earns interest for the years the employee is still working. When the employee decides to retire, the entire amount of money in the account is paid to the employee along with any additional pension benefits. When introduced in 1980, these plans were originally designed for public sector employers. However, over time, they were also offered to police officers, teachers, firefighters, as well as civil servants.
In order to use a DROP retirement plan, you must meet the following eligibility criteria:
The calculation of a DROP benefit plan can differ for different employers. However, most employers consider the following factors while calculating the benefits:
Here is an example of how the DROP account benefits are calculated. Consider a scenario where a public sector employee retires at the age of 60 after working for 30 years. The employee selects a DROP plan with a participation limit of 5 years. The accrual rate of interest for the plan is 2.5%. The employee retired at a salary of $40,000. In this case, the employee will get the total of $40,000 x 2.5 x 30 years = $30,000 in a year. If the participation limit is 5 years, the employee will earn a maximum of $ 3,00,000 in the DROP retirement account as a whole.
DROP retirement plans can offer several benefits to both the employer as well as the employee:
Benefits of DROP pension plans for employees:
Benefits of DROP pension plans for employers:
Disadvantages of DROP pension plans for employers:
A DROP retirement plan is taxed as your ordinary income, depending on the tax slab you fall into. However, the taxability may differ based on how you choose to receive your income at the time of withdrawal. When you quit the workforce for good, you can consider the following four options:
Deferred retirement options plans can be a good option for people who wish to continue working well past retirement. It can also benefit employers in several ways. Hence, these plans are preferred by both parties. However, the suitability of these plans for each individual can only be determined based on your retirement income, tax bracket, and reason for wanting to work more. No matter why you choose a DROP account, you must pay attention to the taxability of your account at the time of maturity. The retirement account should help you earn money and not lose money to taxes. So, make an informed decision after understanding all the pros and cons. It is also important to know the terms and conditions of the employer before you pick a plan and see how the interest and participation limit fit into your retirement planning strategies.
If you need a professional’s opinion on how deferred retirement options plans work and whether or not they are a good option for you, you can get in touch with a financial advisor in your area. Use the free advisor match tool to get matched with 1-3 qualified financial advisors who are suited to meet your needs and goals.
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The blog articles on this website are provided for general educational and informational purposes only, and no content included is intended to be used as financial or legal advice.
A professional financial advisor should be consulted prior to making any investment decisions. Each person's financial situation is unique, and your advisor would be able to provide you with the financial information and advice related to your financial situation.