In our blog post, Let's Dive Into the Florida Retirement System, I provided an overview of the Florida Retirement System (FRS), a state-sponsored retirement plan for certain public sector employees. The FRS consists of two primary components: the Pension Plan and the Investment Plan. In this blog, we'll start by breaking down the Pension Plan and what it entails.
What is the Pension Plan?
The FRS Pension Plan is a “defined benefit plan,” meaning that the monthly retirement benefit is pre-determined based on years of service and average pay. The contributions that must be made are based on what is necessary to meet that benefit goal. All employee and employer contributions go into a trust fund that is invested to fund retiree benefits. Employee contributions are fixed at 3% of pay, but contributions required of the employers change annually based on actuarial calculations, investment performance, and more.
How are your retirement benefits calculated?
The formula used to calculate retirement benefits is:
Years of Creditable Service x Percentage Value x Average Final Compensation = Annual Benefit
Let’s break down these variables. Years of Creditable Service is the number of years the member worked for an employer that participates in FRS. Percentage Value is the value that the member receives for each year worked. In our Let's Dive In blog, I introduced the five FRS job classes that are based on the type of job the member performs. The Percentage Value a member receives for each year of service varies by job class. The most common one, Regular Class, receives between 1.60% and 1.68% per year depending on retirement age and years of service. The next most common class, Special Risk Class, receives 3% per year of service. The final variable in the benefits formula is Average Final Compensation. This is an average of the member’s highest five or eight years of pay. Those enrolled in FRS prior to July 01, 2011, use the five-year average and those hired after that date use the eight-year average.
Let’s look at this with an example. Ima Educator worked as a Florida Public School teacher (Regular Class member) for 33.7 years before retiring. Her Years of Creditable Service will therefore be 33.7. Her Percentage Value based on having worked over 33 years will be the maximum for her job class at 1.68%, or 0.0168. Ima’s Average Final Compensation, the average of her highest five years of pay, is $68,250. Ima’s annual pension benefit will be (33.7 x 0.0168 x 68,250) = $38, 640, or $3,220 per month. Ima will also be eligible for a 3% cost-of-living adjustment on her years worked in FRS prior to July 01, 2011. Since Ima worked for some years prior to that date and some years after, she will receive a prorated cost-of-living adjustment percentage based upon (you guessed it) a formula.
DROP
Pension Plan members have an option available when they become eligible to retire that will allow them to keep working for several more years and at the same time build up some retirement savings through the Deferred Retirement Option Program (DROP). To enter DROP a member must be eligible for normal retirement based on age and/or years of service. Those who elect to participate in DROP can work for an additional 5 years (8 years beginning July 1st, 2023) while their pension payments go into a tax-deferred account earning a fixed interest rate. The ability to keep earning a paycheck while also earning your pension is an exceptional opportunity. When the member’s 5-year (or 8-year) DROP term is up they retire, begin receiving their monthly pension payments, and receive the funds in their DROP account. They can roll this lump sum into an IRA, roll it over to the FRS Investment Plan, or take it in cash as a lump sum. Taking the cash as a lump sum results in that amount being taxable as ordinary income in the year it occurs, and is almost always a bad idea.
The Pension Plan and DROP are complex topics and there are many more specifics that are too lengthy to cover in this article. Requirements to qualify for normal retirement, vesting requirements, disability benefits, early retirement penalties, and many other topics are important to consider in making retirement decisions. It is critical to consult with a trusted advisor who is knowledgeable about FRS prior to making any decisions that may be irreversible.
In our next Florida Retirement System blog, we will examine the Investment Plan and how to determine which plan is best for you. Stay tuned, and if you have specific questions concerning your pension choices, give me a call at (863) 688-1725 or email me at Rick@cpsinvest.com.
Want a guide to help you understand the Florida Retirement System? Our Journey to Retirement Flowchart maps out your route to retirement. Click the button to download!
About Richard
During his time in public service, Rick was dismayed at the number of people, including other public servants, who failed to plan for retirement and ultimately made poor financial decisions when it was time to retire; many were ultimately forced to return to work. Realizing that sage and timely advice from a financial planning professional could have prevented these unfortunate outcomes, Rick was determined to pursue a second career helping people plan for and achieve a financially secure retirement.
