Las Vegas POA

DROP Reform Does Not Violate Constitution

Written on 04/03/2020
Will Aitchison

The Dallas Police and Fire Pension System is a public pension fund that provides comprehensive retirement, death, and disability benefits for approximately 9,300 active and retired City of Dallas police officers, firefighters, and their qualified dependents. Under the retirement plan, individuals become members of the pension system once they commence training at the police or firefighter academy. The member and the City contribute to the member’s account during the member’s active service.

One of the benefits of the plan is a Deferred Retirement Option Plan (DROP). The pension system began offering DROP accounts in 1993 as an incentive to retain experienced police officers and firefighters after they attained eligibility to retire. Under DROP, a member could freeze his or her retirement benefit and continue working, receiving both a salary and an annuity payment from his or her retirement account.

While the member electing DROP continues on the job, the monthly annuity is paid into the member’s DROP account. Once the member has left active service, future annuity payments are redirected to the member, who is also now eligible to withdraw funds from his or her DROP account. DROP accounts initially collected an attractive interest rate and provided the member several options for withdrawing funds at the end of active service. Under these options, the member could elect a lump-sum distribution, an annuity based on the member’s life expectancy, or disbursement based on monthly or annual payments designated by the member.

DROP accounts became very popular. Eventually, the amount of money drawn into these accounts, together with a member’s right to elect a lump-sum distribution on leaving active service, threatened the liquidity and stability of the pension system. These concerns motivated the Texas Legislature to pass House Bill 3158 in 2017, amending the applicable pension statute to eliminate lump-sum payments and to permit only the annuitized option for DROP account withdrawals.

A group of retirees sued the state, alleging that the Bill impaired accrued retirement benefits in violation of Section 66 of the Texas Constitution. A federal appeals court hearing the case referred several questions to the Texas Supreme Court about the interpretation of the Texas Constitution. The Supreme Court ruled in favor of the constitutionality of the Bill.

The Supreme Court reasoned, “Our guiding principle when interpreting the Texas Constitution is to give effect to the intent of the voters who adopted it. The history of Section 66 indicates that its impetus was a Depression-era decision from this Court that subordinated the pension rights of public servants to the authority of the State to diminish or abolish future pension payments. The retirees complain that the Bill violates Section 66 by retroactively voiding previous elections and effectively denying them access to their accrued benefits. They essentially contend that the funds in their DROP accounts have been reduced or impaired because the retirees no longer have unfettered access to them.

“But the reform here does not negatively affect the amount of money in the retirees’ DROP accounts. The monthly annuity payments and earned interest collected in those accounts are neither reduced nor impaired. Only the rate at which the retiree is permitted to withdraw these funds is affected. While an outright denial of access to these funds might reasonably be considered an impairment, the complaint here is that the pensioners’ choices about access have been impaired by the statutory reform that eliminates two of the three previous methods of distribution.

“The question of this reform’s retroactive effect is more nuanced, however. The underlying statute previously permitted a DROP participant to elect one of three alternative methods of distribution from the fund – an election that, under the statute, could be changed at any time before the participant left active service. Thus, the change is retrospective in the sense that previous elections about how the DROP participant anticipated having the funds distributed are superseded by the statutory amendment mandating monthly annuity payments.

“But does that change implicate Section 66 by reducing or impairing the accrued benefit? The retirees argue that it does because their election to take a lump-sum distribution has a greater net value to them than the annuity that replaces it under the pension reform. Even assuming that to be true, we fail to see how the benefits in their respective accounts have been reduced or impaired by the elimination of this election or the flexibility it provided under former law.”

Degan v. Board of Trustees, 2020 WL 508654 (Tex. 2020).

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