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September 06, 1999 01:00 AM

DEFERRED OPTION: PUBLIC PENSION PLANS ADOPT DROPS FOR OLDER WORKERS; LUMP-SUM PAYMENTS CAN GO AS HIGH AS SIX FIGURES FOR RETIREES

Terry Williams
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    Jazz music and Cajun cuisine are two of Louisiana's great contributions to American culture, but they may be surpassed by a "wrinkle" in a defined benefit plan that is putting lump-sum payments -- sometimes of as much as six figures -- into the pockets of civil servants.

    Deferred retirement option plans are the hottest craze on the domestic public pension scene. The first one was implemented by the Baton Rouge and Parish of East Baton Rouge Retirement System in Louisiana in 1982.

    A DROP is basically an alternate payment of the pension benefit.

    There are variations among the plans, but most require an employee who has worked enough years to be eligible for a full pension to continue to work an additional two to five years.

    The employee earns his or her salary, as well as any salary increases, but the retirement benefit earned prior to entering the DROP program is frozen. The employee also doesn't earn any additional service credits.

    The monthly benefit that the employee would have received in retirement is placed into an interest-bearing account; in a few instances, the accounts are self-directed. The employee receives the tax-deferred benefit as a lump sum at the end of the DROP period when he or she retires, as well as the monthly retirement benefit.

    "It's sort of like a giant IRA (individual retirement account)," said Bonita Brown, assistant director of the $11 billion Teachers' Retirement System of Louisiana, Baton Rouge. "You still get a salary, but you are able to save this tax deferred.

    "It's a once-in-a-lifetime opportunity to accumulate a large pot of money and not suffer," said Ms. Brown, whose system has a DROP plan with $435 million for 3,600 participants.

    "It can add up to six figures in a few years," said Leslie Finerty, unit leader of consultant Towers Perrin's retirement division, San Francisco."Most of us can't save that much."

    DROPs are popular among public safety and teacher retirement systems.

    "Police and firefighters can get out at a fairly early age," said Joseph Jankowski, director, retirement plan consulting services with ICMA Retirement Corp., a Washington money manager. "They are in their mid to late 40s and are willing and capable of continuing working."

    Police and firefighters often begin second careers because their options are limited in their first professions.

    "When you are a 49-year-old firefighter, you don't retire and go to another department," said Jeffrey Yates, retirement administrator for the Baton Rouge retirement system.

    Cities and states want to keep the firefighters and police officers rather than incur the expense of recruiting and training new employees, Mr. Jankowski said.

    The motivation with teachers is slightly different. Several states are finding it difficult to attract teachers and are offering DROP plans as an incentive to keep them around for a few additional years.

    Florida, for example, needs 12,000 new teachers annually, but its colleges generate only half that. DROPs are very popular in the Sunshine State.

    The $101 billion California State Teachers' Retirement System, Sacramento, expects to research a DROP in the next few months. "We are in a teacher shortage in California," said Sherry Resser, a CalSTRS spokeswoman. "We would be using this to recruit teachers."

    Teacher retirement systems in Arkansas and Florida have DROPs, Ms. Brown said. Several public funds in Louisiana and Florida have DROPs; there are several in Texas; and they may also be found in Oklahoma, Colorado, Missouri and Maryland.

    "It's been mutating and spreading like a virus," Ms. Brown said.

    There is no accurate measure of the amount of assets held in DROP plans, Mr. Jankowski said.

    ICMA should know. The company is selling a service to administer self-directed DROPs, one of many permutations found with these plans.

    "We don't have a precise dollar amount," he said. "Most DROP assets are still assets of the defined benefit pension plan. The DROP is simply a distribution option. In most cases, it's not accounted for separately."

    Baton Rouge was not trying to entice employees to stay when it implemented its DROP. The administrator and two members of the fire and police pension fund were trying to fight the eroding effect of inflation on the pensions of participants.

    "In the early 1980s, there were hard economic times, and the City Council thought about not approving a cost-of-living increase," said Mr. Yates, the administrator for Baton Rouge's $810 million retirement system, of which $68 million is DROP assets. Mr. Yates was an accountant for the system at that time.

    Charles Carter, the police representative; Curtis Cox, a firefighter who has since died; and Gary Van Oss, the administrator at the time, came up with the idea for the DROP, Mr. Yates said.

    "We jokingly said it would be nice if you could retire and keep working, and live off your earnings," said Mr. Carter, recalling the germination of the idea. The concept sounded better the more the men discussed it, and they eventually asked the system's actuary to run the numbers to determine if it could be done without harming the system.

    The actuary -- Richard F. Camus & Associates of New Orleans -- determined that the plan could be cost neutral if a participant worked 25 years, and if the plan sponsor didn't contribute its 19% to the system.

    Also, the employee would keep his or her 8% contribution to the system since they were retired and also wouldn't be making contributions.

    The only contribution to a DROP is the monthly benefit the employee would have received had he or she retired. Instead of arriving as a check, the money goes into an interest-bearing account for the employee.

    "It was a savings all the way around," said Mr. Carter, who retired in 1989 after 32 years. "It sounded too good to be true.

    "Maybe it took some simple police and firemen to start it up."

    "All the numbers made sense," Mr. Van Oss said. "We can't say anything but good things about it."

    Not much bad is being said about DROPs, but they aren't for everyone.

    For a retirement system, the key is structuring the DROP to be cost neutral. The actuaries' estimate of when an average employee will retire has to match, as closely as possible, the number of years needed to work to qualify for entry into the DROP.

    "If the retirement age is lower, it could compress the time in which benefits need to be funded and it could increase annual funding costs," Mr. Jankowski said.

    Employees also must be encouraged to leave once their period in the DROP plan is ended. Baton Rouge's system imposes severe penalties if an employee doesn't leave.

    "We take away all interest earned and distribute it to the employee as a taxable event," Mr. Yates said.

    An individual may find a DROP unattractive if that employee is expecting a significant increase in salary in the last few years of employment.

    "You won't get that high salary figured into your monthly benefit," Ms. Brown said.

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