If you made after-tax pension contributions, your DROP funds may include after-tax “basis”. “Basis recovery” is the process by which your after-tax employee pension contributions are returned to you, free of taxes, as part of your pension benefits. You may have made after-tax contributions for any of the following reasons:
From 7/1/82 -12/20/96, mandatory pension contributions were collected after-tax.
Elective purchases of service credit made by contract or lump sum payments were collected after-tax. (Trustee-to-trustee transfers from Deferred Compensation are pre-tax.)

The voluntary 2% “opt-in” pension contribution by certain members in order to vest future retiree medical subsidy increases are collected after-tax. (Note: This does not apply to Tier 6 members.)
The Internal Revenue Code includes a provision that allows DROP members to recover a portion of their eligible after-tax contributions using an accelerated method. This method allows you to take a lump sum distribution of any eligible after-tax DROP funds, rather than recovering it in payments over your lifetime through the Simplified Method. Members exiting DROP on or after January 1, 2014 will be subject to this basis recovery method and may:
Recover pre-1987 after-tax contributions entirely from the lump sum DROP distribution.
Have any post-1986 after-tax contributions allocated pro-rata between the lump sum DROP distribution and the member’s ongoing monthly pension annuity. Any after-tax funds included in the monthly pension annuity will be subject to the Simplified Method. The Simplified Method, developed by the IRS, is the formula that determines the amount of your pension that will not be taxed for a fixed number of months in retirement based on your age and the age of your qualified spouse/domestic partner, if applicable.

Distribution Options – Effective January 1, 2014

Review the options below to select a distribution election for both your taxable and non-taxable DROP funds. Please note, if you rollover any non-taxable portion, you must also rollover your entire taxable portion.

OPTION
NON-TAXABLE DROP FUNDS
TAXABLE DROP FUNDS
1
Lump sum cash payment of eligible non-taxable funds
Direct rollover of all taxable funds
2
Direct rollover of all non-taxable funds
Direct rollover of all taxable funds
3
Partial lump sum cash payment and partial direct rollover of non-taxable funds
Direct rollover of all taxable funds
4
Lump sum cash payment of eligible non-taxable funds
Partial lump sum cash payment and partial direct rollover of taxable funds (partial lump sum cash payment subject to mandatory 20% Federal tax withholding)
5
Lump sum cash payment of eligible non-taxable funds
Lump sum cash payment of all taxable funds (subject to mandatory 20% Federal tax withholding)

All rollovers must be made to one financial institution of your choice for either the non-taxable or taxable portions of your DROP account. It is important to note that not all plans can accept a rollover of non-taxable funds, so please confirm with the plan of your choice before making any elections for a direct rollover. For example, the City’s Deferred Compensation Plan does not accept rollovers of non-taxable funds. Therefore, if you select Options 2 or 3, you must roll your non-taxable funds to an institution other than Deferred Compensation.
You must complete a DROP Distribution Form within 90 days of your DROP exit date to determine how you wish to recover your after-tax contributions. After 90 days, the distribution of your DROP account will be limited to a lump sum cash payment only, subject to mandatory 20% Federal tax withholding for the entire account balance. The Board Operating Policies and Procedures (Pension Processing, Section 3.2.3) have been amended to reflect the basis recovery method.
For more information review the DROP Basis Recovery FAQs. For any questions, please contact DROP/Service Pensions at (213) 978-4575.