When Danny Knight, 60, resigns his job as superintendent in the Watson Chapel School District on Dec. 1, he plans on rolling over what could be hundreds of thousands of dollars in his T-DROP retirement plan into a tax-deferred, interest-bearing account.
Then, he hopes to be rehired by the district in January — and become the first teacher in the Arkansas Teacher Retirement System to make use of a loophole in the law that created T-DROP, a lucrative retirement account created 10 years ago to persuade seasoned teachers to stay on the job.
The year T-DROP (Teacher Deferred Retirement Option) was created — 1995 — more than 30 Arkansas teachers opted into the account, in which 70 percent of what a teacher’s retirement benefit would be at 28 years is invested at between 2 percent and 6 percent interest yearly, compounded, along with cost-of-living raises. (Until two years ago, the accounts earned 6 percent interest; interest then dropped to 3 percent.)
An employee who could expect to retire at $20,000 a year after 28 years could have more than $200,000 in a T-DROP account (invested at 6 percent) at retirement 10 years later, plus an annuity from the payments made before the T-DROP investment. (Retired teachers may get their T-DROP as a lump sum or an annuity.) A person making $50,000 at retirement could accumulate as much nearly $354,000 in the account.
After 10 years, the T-DROP account is frozen. No more money is added and it does not earn interest for the retiree. If a teacher chooses to keep working past the T-DROP cap date, his or her retirement will not grow accordingly.
And that’s what drove Knight to take the unusual step of retiring and arranging to be rehired. He could be the first of many of the initial 30 who took advantage of the T-DROP program at its inception.
Lump sum withdrawals from T-DROP, though they could amount to tens of thousands of dollars, won’t hurt the account, David Malone, executive director of the Arkansas Teacher Retirement System, said. There are currently 4,565 teachers enrolled, and the account’s assets stand at $335.4 million.
But the loophole, as he called it, presents a couple of significant problems: First, the Internal Revenue Service requires the retirement agency to pay only retirees. The IRS could interpret retirement payouts to persons who return to work as a salary supplement, rather than retirement — and cost the ATRS its tax exempt status.
Second, when retired teachers fill slots that could have gone to active teachers, less money goes into the retirement system. Teachers don’t contribute to the retirement system if they’ve retired, working or not. The system loses the 20 percent that would have been invested from a teacher’s wages.
Now, there are three teachers paying in for every one teacher drawing retirement, Malone said. But the retirement system’s studies project that to decline to one to one over the next 20 years. “I need active people in the system,” Malone said.
Knight will face a penalty for withdrawing retirement and going back to work. An earnings income limit will be imposed — roughly $28,000, or twice the Social Security limit — and Knight will lose $1 from his annuity for every $2 he earns over the limit. But Knight, who earned $113,000 a year as superintendent, figures he can make more by withdrawing and investing his T-DROP and taking the penalty than by leaving the account alone until retirement age. He said that “if the board chooses to hire me back” — which is clearly part of the plan — the penalties will reduce his annual pay to “what I made in the ’99 school year.”
Knight argues that teacher retirement penalizes teachers “for working.”
“If a person is 60 and chooses to continue to work, you’ve got money in the DROP account that you receive no benefit from — but teacher retirement continues to draw interest. You receive nothing.” And he argued that if he rolls his T-DROP over into a tax-deferred account rather than cashing in, the IRS can’t consider the amount a “salary supplement.”
Knight, who started work at 20, was 50 and a 30-year veteran of the schools when T-DROP was created. He said T-DROP’s creators didn’t anticipate the problem that capped retirement for persons younger than 65 would pose.
If he doesn’t retire, Knight said, “every day I work is gravy to them because … they’re earning money on my money.”
Knight is not alone in his opposition to capping T-DROP. Bill Ray Lewis, a Harrison school administrator who supported the creation of the account, noted in a letter to this newspaper that the statute did not put the 10-year cap on the account. The cap was a decision of the Teacher Retirement System’s board, and a “misguided” one, he said. Lewis is encouraging retirement system members to urge Malone and his board to lift the cap.
But Malone said actuarial data suggests that if the T-DROP account were extended, it would no longer be “cost-neutral.”
He is pondering changes to the T-DROP regulations. He said he’ll probably propose that teachers be at least 55 to opt into the account. That way, they’d be retirement age at the 10-year limit and would be able to access the account without any penalties.
The Arkansas Education Association hasn’t taken a position on the T-DROP except to say that “what’s available for one should be available for everybody,” Paul Greer, director of legal services for the AEA, said. He added that he wouldn’t be surprised if the IRS didn’t take a look at the situation with Knight, and perhaps others who have hit the 10-year limit this year.
Does T-DROP do what it was supposed to do — keep teachers in the system longer? Malone said the evidence is mixed.