DROP plans are really hybrid pension plans – a cross between a traditional pension (defined benefit) and the newer defined contribution plans. In the end, you have both a lifetime pension and a lump sum rollover.
I'm not sure if many private pension plans have the DROP options, but there are many public sector plans: state, county, city and teacher pension plans, with DROP.
The DROP plan allows the employee to retire from the pension plan, but remain fully employed. During the years they are a DROP participant, the monthly pension amount is “deferred” into a DROP account in the participant's name.
They do not gain in a higher pension benefit, the benefit and retirement options have been calculated and are fixed for life.
The plan can administer the DROP policy in many different ways. They can calculate the full pension that goes into the DROP account, or they can choose to DROP a percentage of that pension (say 80%). Normally, there is a maximum time limit that an employee can remain in DROP – that doesn't mean they must retire, but it does mean that the DROP payments might end.
When the participant chooses to retire, the employer pays out the monthly pension, like they would with any other retiree. They also do a plan to plan transfer or payout of the DROP account to any IRA that the participant chooses.
A public employer cannot allow an employee to double dip, receiving both pay and a pension from the same employer. However, with the DROP plan, the pension is not “paid” to the employee. It is transferred into a DROP fund and held until the participant terminates employment.
The employer wins as they can keep a long term employee, without losing them to retirement. Sometimes their employee benefit levels might change, but they have the same paycheck and are now contributing, via the DROP, towards another retirement plan.
Defined Benefit Plans (traditional)
Defined Contribution Plans (newer plans in the last ten years)