At the end of your DROP participation, if you elect to have your DROP accumulation rolled over to another eligible retirement plan as defined in section 402(c)(8)(b) of the Internal Revenue Code, you owe no taxes on your DROP accumulation until you begin to withdraw these funds from the eligible retirement plan.
When you begin to withdraw these funds, the income taxes you owe are based on your income tax rate in the year you receive the funds. If you choose a total or partial lump-sum payment of your DROP accumulation, the lump-sum amount will be taxed as income in the year the payment is issued. The Internal Revenue Service (IRS) requires that the division withhold 20 percent of this amount for taxes when distributed to you.
You could owe additional income taxes based on your income tax bracket. Also, unless you terminate from DROP in or after the year you reach age 55 (or age 50 for eligible public safety officer retirees), you may owe an additional 10 percent early withdrawal tax on your lump-sum distribution. Please consult the IRS at www.irs.gov, or your tax advisor, for more information.
Example: If you choose to take a lump-sum DROP distribution of $100,000, the division automatically withholds 20 percent ($20,000) for taxes. The amount of the lump-sum distribution paid to you would be $80,000 ($100,000 – $20,000). The 1099-R tax form the division sends you for that year would include the lump-sum amount you received and the 20 percent tax withheld. If you are in the 28 percent tax bracket that year, you would owe an extra 8 percent ($8,000) in taxes to the IRS. If your termination from DROP occurs before the year that you reach age 55 (or age 50 for eligible public safety officer retirees), you may also owe the IRS an additional 10 percent tax ($10,000) on your lump-sum distribution.