The decision over whether to enter, or not enter the DROP (Deferred Retirement Option) is one of the most important career decisions will ever make as a Maryland State Trooper. To make matters worse, to DROP or not to DROP is also one of those decisions that almost everyone has an opinion on—and unfortunately, not many opinions are alike. To be sure, this is an emotional decision, a financial decision, a career decision, and finally, a family decision, so seek advice from your spouse and/or family.
This month’s article will give you a good financial base from which to make your decision—other issues are person-specific and must be evaluated by the individual, taking into consideration all the various personal factors unique to their situation. But the financial factors are fairly straight forward mathematical number-crunching, and though you may have overheard water-cooler talk, or spoken to someone who talked to someone else who apparently “ran the numbers,” do you really understand the value of the DROP? Here we’re going to estimate, on paper, once and for all, what it means in dollars, longterm, to enter the DROP.
Perhaps the easiest way to clear up the fuzziness of the DROP is to use a demonstration Trooper and run the numbers for a hypothetical trooper. Then during your decision making process you can substitute your salary into the example and you should come away with at least a rough estimate of the monetary value if you do DROP. This article will also talk about the timing—there is a limited window when you can DROP—you must have at least 22-years on the job, and you can’t stay in the DROP after your 28th year.
We will call our hypothetical Trooper Al Goodman. TFC Goodman began his career in the Maryland State Police 22 years ago at age 21, making him eligible to enter the DROP. He wonders if he should DROP and if so, exactly when will it most benefit him.
In this scenario we use several assumptions that remain consistent and are equal for all decision paths. TFC Goodman’s current salary (without overtime) is $60,000; his last two years were $58,500 and $57,037 for a 3 year average of $58,512. We’ll always use a 2.5% riser for his salary if he stays on the job and we’ll always use a 2.5% Cost of Living Allowance (COLA’s) on retirement checks. TFC Goodman has 2,112 hours of sickleave— or an extra one-year credit on his service-time (22 days sick leave = 1 month of credit). He’s a healthy person and will not use anymore sick-leave (S/L) during the example. Saving S/L is an important and valuable decision by TFC Goodman since S/L increases his retirement percentage multiplier without cutting into his DROP time—this increases his monthly payout for the rest of his life, and even Mrs. Goodman’s life if she outlives him.
By crunching the numbers on an Excel spreadsheet we can estimate the value of each decision point, year-by-year for the next few years of TFC Goodman’s career. I’ve calculated the lifetime income received until TFC Goodman reaches age 82. Why 82 you might ask, well we have to stop sometime—we all stop sometime–and if you asked Al right now if he’ll take age 82, he’ll happily say yes!
We do not factor in the time value of money or tax issues—both concepts are beyond the scope of this article—but neither would adversely affect one strategy over the other. We all have to pay taxes and a dollar today is always worth more than a dollar next year.
Now, one of the first things you notice when you DROP is an increase in your paycheck—you no longer pay your 8% contribution into the Maryland State Retirement account—that bonus is calculated in the numbers. (Often overlooked by administrators is that the State of Maryland also stops paying into your retirement—quite a benefit to Maryland too.)
So, without further ado, here are the results of about 5 hours in an Excel spreadsheet:
TOTAL ACCUMULATED VALUES OF PENSION, DROP AND SALARY Year Retires DROP Value @ Age 82 (Assuming 6% APY1) Pension & Salary Cumulative @ 82 Total Value at Age 82 22 $1,475,215 $2,235,523 $3,710,738 23 $1,558,126 $2,387,221 $3,945,347 24 $1,574,451 $2,544,715 $4,119,166 25 $1,193,350 $2,640,929 $3,834,279 26 $826,295 $2,560,737 $3,387,032 27 $416,242 $2,701,821 $3,118,063 28 $0 $2,787,123 $2,787,123
You will notice that the value of the total payments made to you through the pension steadily increases the longer you stay on the job–$2.23 million to 2.78 million–this is due to the increase in the pension multiplier (2.55% per year capped at 71.4% @ 28 years.) Going “out-early” definitely decreases the overall value of the pension payments. But the total value hits the financial sweet-spot with a retirement after 24 years of service, and four years in the DROP—with the total value reaching $4.11 million ($1.57 DROP + $2.54 Pension).
And here’s the reality of pension payments—you will spend what they send you—salary and pension payments of $2.78 million is a lot of money—but this is the lifetime accumulation of your monthly pension checks—if you are typical, you will not save much of this money—if it hits your checking account on Wednesday chances are by Friday it’s all but gone, mailed off to pay the credit card, the mortgage, junk from the KMart, the kids tuition, etcetera. Ask yourself, with the day-to-day bills and demands on your checking account now, do you actually save any real money. It’s no different when you’re retired. The next chart shows the true value and benefit of the DROP:
DROP VALUE AT THE END OF PARTICIPATION End of Year 1 Year 2 Years 3 Years 4 Years 22 $37,081 $77,315 $120,914 $168,102 23 $39,799 $82,981 $129,774 $180,420 24 $42,629 $88,881 $139,002 $193,249 25 $45,575 $94,000 $146,472 X 26 $48,642 $101,420 X X 27 $51,089 X X X
Even if you DROP for just a year, when in your life have you been able to save $51,089 in one year? And no matter how frugal you are, has any Trooper been able to save $193,000 in any four-year period? I don’t know anyone.
Good ole Al can walk away from the Department at age 47, with a pension for life, and an IRA with a starting balance of $193,249. And if Al invests his IRA in a vehicle that averages 6% per year, Uncle Al can leave his family an IRA worth about $1.5 million dollars. Or better yet, Mr. and Mrs. Goodman can use the money for the retirement they’ve always dreamed of. While the Government just made it is possible for Al to access the funds when he turns 50 without penalty2, the longer he waits the greater the account grows—by letting the magic of compounding interest take over, he can truly have a very comfortable retirement.
I hope this article helps with your decision—remember, this only covers the math of the decision; there are many other factors to consider. Please keep in mind that you are leaving one of the finest law enforcement agencies in Maryland, you are leaving your law enforcement authority behind, and you are leaving probably the best job you’ll ever have. In the end, you have to decide if you’ve really had enough of MSP; it’s not just a financial issue.
Financially speaking though, the best possible scenario is to enter the drop with as much sick-leave as possible, at the end of your 24th year, complete 4 years in the DROP and then start your second career with a nice monthly pension check and a lot of money in the bank!
1This article does not promise or guarantee 6%, but merely uses the number as a tool for comparisons of options—all options use the same 6% assumption.
2Recent legislative changes permit public safety employees to access funds from a defined benefit plan at age 50 without penalty—see Pension Protection Act of 2006
Marty Knight, MBA is a retired Captain from the Maryland State Police and is currently a Financial Advisor with Chesapeake Investment Advisors, Securities and Advisory services are offered through Geneos Wealth Management, Inc. Member NASD/SIPC.