The FRS Pension OptionJan 14, 2020
By Glenn J. Downing, MBA, CFP®
Employer-sponsored retirement plans can be split into two groups:
- Defined Contribution Plans, or DC Plans
- Defined Benefit Plans, or DB Plans
As the name suggests, the salient feature of any defined contribution plan is the input – how money goes into the plan. Money goes in from employer contributions and matching, employee deferrals, and forfeitures from those not vested.
On the other hand, the DC plan is defined not by the inputs, but rather than by the output. The Florida Retirement System pension option is a defined benefit plan. I explain this a little more fully in my video.
The Investment Risk is With the State - Not You
With any defined benefit plan, all the investment risk is with the employer and not the participant. When I say the risk is with the employer, I mean the State of Florida. FRS invests the retirement plan assets in such a way that it is able to pay out what has been promised. The employer is guaranteeing the participant a fixed income for life, regardless of whether underlying investments do well or poorly.
With the FRS there is a pension formula based on years of service and average of the highest 8 years of salary. The formula calculates a pension amount that is guaranteed over the pensioner’s lifetime or lifetimes of the pensioner plus spouse.
Is My Pension Payment Safe?
In short, yes. The good news here is that Florida’s pension system is found in the top 10 most solvent plans in the nation, being funded at a level to pay upper 80%s to lower 90% of all its pension liabilities. Florida some years back gave people options – called a hybrid retirement system. Some choose the investment option -far cheaper to the state – and some choose the pension. Even the US armed forces rolled out a hybrid system in 2018.
This is in stark contrast to the economic basket case states like Illinois, California, and my home state of Connecticut. The CA pension system is estimated to be $500 billion – that’s ½ a trillion – underfunded! What does that mean? It means basically that the pension funds of those states cannot afford the pension benefits promised. To be 1/2 billion unfunded means that to bring the CA pension funds up to snuff would require a cash infusion today of 1/2 billion. Not terribly likely.
What can those states with underfunded pensions do? What Florida did – give people options. At some point, these states will have to cut benefits or raise taxes, or the pension checks are going to start bouncing. So far they’ve raised taxes, and the taxpayers are voting with their feet – moving to low tax states like TX and FL.
Can I Switch Between the Pension and Investment Options?
Each participant in FRS can make a one-time election to switch to the other plan i.e. from Defined Contribution to Defined Benefit, or the other way around. Here’s a circumstance where this might make sense:
Say you started teaching right out of college, and you thought you’d only teach for a few years until you got married. Because you thought your FRS employment was to be relatively short, you chose the Investment option. But now 10 years have gone by and you find your teaching career fulfilling with no end in sight. You switch to the pension option, knowing that 30 years participation will entitle you to a DROP payment and early retirement.
The Florida Retirement System is subject to ERISA law. ERISA is the Employee Retirement Income Security Act of 1974. Per ERISA guidelines, the maximum defined benefit pension that can be paid to anyone in 2020 is $230,000.
A Word About DROP
Defined benefit pensions are now usually only found as public employee benefits. Much of the private industry has gotten rid of their pensions in favor of defined contribution plans, where all the risk for the outcome is on the participant himself. So choosing between a pension and a potentially larger investment account at retirement is a choice to be made carefully.
Another salient point in Florida is the DROP – Deferred Retirement Option Program. Those who’ve chosen the FRS pension option can retire, work 5 more years, and have their pension payments accumulate in a DROP account. This is a very rich retirement, and we’ve seen no counterpart to it in private industry. Basically what happens is this: If you enter DROP in 2020, you may work up to 5 more years. You’re out in 2025, in other words, ready or not. During those 5 years, your pension is paid into an interest-bearing account for you. So you’re double-dipping – working while drawing your pension. If you have a pension of, say, $5000/month, at the current rate of 1.3%, your DROP payment will be $309,791!
You may find my YouTube video helpful, DROP for FRS Participants.
Where do I get unbiased advice?
From someone with no conflict of interest. That means someone who doesn’t have something to sell you. It pains us to hear of so many teachers and municipal employees who have stuck their DROP payments into annuities. You already have tax deferral because your DROP payment is retirement money! Why pay annuity fees for something you already have? Our work is always custom and focuses on the individual needs of the client. As registered investment advisers we have no product to sell you. We’re not pushing to make a sale so we can generate a commission. And as CERTIFIED FINANCIAL PLANNER™ professionals, you can count on us for a fiduciary standard of care – meaning unbiased financial advice, always in the client’s best interests.
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Check out Glenn's piece on the FRS Investment Option. Questions? Feel free to get in touch with us at [email protected] Also follow us LinkedIn, Facebook, Instagram, and YouTube for more personal financial information relevant to you!
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