FRS DROP Payout Option 1 – The "I Love Uncle Sam" Option
For those in the Florida Retirement System Deferred Retirement Option Program (aka DROP), there are 3 payout options when they separate from service. These payout options are elected on the DP-PYT form which is located in your DROP exit packet. The DROP exit packet is usually received 3-4 months before the retiree exits DROP.
The DROP payout option is one of the most important financial decisions that the participant will ever make. Let’s go over the first payout option available.
The first payout option is a lump sum cash out option. As most people know, the FRS DROP account is pre-tax money, meaning that distributions to the participant is a taxable event. The FRS will send 80% of your total DROP balance to you and 20% of the total DROP balance to the IRS for taxes. Our office jokingly calls this option the “I Love Uncle Sam” Option because of the potential tax ramifications that can occur if it is chosen.
Remember: Your tax bracket is determined on the amount of income you earn per year. So if you take a large taxable distribution in one year + wages + retirement income, you may end up in a higher tax bracket than the 20% that is withheld and sent to the IRS. THE 20% WITHELD IS NOT HOW MUCH YOU OWE IN TAXES, THAT IS JUST THE AMOUNT REQUIRED TO BE SENT AT THE TIME OF DISTRIBUTION. We have met many people who have unknowingly chosen this option and have gotten tax bills for $20,000+.
The most common reason someone choses Payout Option 1 is because they want to pay off a large bill or mortgage. The potential tax ramifications can usually be avoided by paying off those bills over a 3-5 year time frame. You can park your money in a fixed and liquid qualified account, and take systematic distributions at your discretion to control your tax liability.
If you’re planning on picking Payout Option 1, please consult a tax professional first.