Executive Savings Plans

[Toocold]

I work for a company that offers a ESP program, which allows me to deferred 80% of my salary and 100% of my bonuses. It works such that at employment termination, I can choose a 1, 5, or 10 year payout period. My employer is a highly stable megacorp.

I am considering deferring 80% of my base and bonus in the ESP, which will allow me to save up substantial pre-tax investment. The 20% is enough to max my 401k, invest in a ESPP, continue to fund my kid's 529, and support daily living expenses (augmented by current dividend payouts) at dramatically lower tax rates. The 80% should allow me to get to ~$1.5M in pre-tax assets in 3-4 years, so if I quit working, I'd have 10 years of 150k payments, taxed at much lower rates.

Has anybody used ESP as a vehicle to help bridge income in this manner? What am I missing?

 

[MooreBonds]

I work for my family's construction business. I've been trying to talk them into doing a NQDC (non-qualified deferred compensation plan) like you mentioned. There was another thread a few months ago on this topic.

If you are THAT sure about your employer not going bankrupt - all assets in the NQDC plans are paid out to creditors in bankruptcy before ever going to any employees that have a claim for the NQDC - then it can definitely make sense.

Your Medicare/SS taxes are withheld from the contributions, so you won't be getting a full 80% salary deferral. But close enough.

Also, check the investment options available. They can vary widely, even more widely than your 401k options, and possibly be even worse, since the company will most likely have different investment offerings in their NQDC plans vs their 401k plans, and possibly even have different administrators for it. While it can save on taxes, if your investment options are truly pitiful, it could very well make sense to still pay your income taxes now and be able to have full control over the investments. Over 10 years, if your investment options in the NQDC plan are crappy enough, you could very well be looking at a 2% differential in total expenses/returns between what you could invest it in in a taxable account vs what the NQDC is offering, and over 10 years, that could add up.

Also, when the money is withdrawn from the NQDC, it's taxed at ordinary income rates. So any capital gains or qualified dividends earned in that NQDC account will be taxed at your full income tax rate, not the 0%-15% long term cap gains/qualified income rate if you had taken it as income and invested it on your own.

So, if you have really crappy investment options, and your gains you withdraw are taxed at higher income tax rates, it could very well be almost a wash.

You'd also want to look at what your income tax rates would be now vs in the 10 years you are retired, both federal as well as state.

One thing that's confusing me is your %ages you reference. You say 20% will max out your 401k, which suggests a salary of about $100k/year. You then say in 3-4 years you can defer 80% of your salary and arrive at $1.5M in pre-tax assets, and then spread out the distributions over 10 years with $150,000/year.

Where are you getting $1.5M from in 3-4 years, when your salary is only around $100k? Do you have massive bonuses each year? If you have existing 401k assets, you cannot transfer them into the NQDC plan and take them out over 10 years with the 80% voluntary deferral. Your 401k has to follow the rules of nothing before age 59 1/2 (or 55 if you retire/are laid off), unless you do an SEPP. It's a completely separate deal from NQDC plans.

[edited to add: I see where you mention the 20% will be 401k as well as living expenses, 529 plans, etc. - so it's obvious the salary is a bit more]

 

[Toocold]

Appreciate the response MooreBonds. I didn't realize that Medicare and SS are withheld. I hope this also implies that it won't be deducted during distribution.

The funds are fairly good. I'm AA 75%/25% with Vanguard S&P, Small Cap, International, and D&C Income.

Megacorp is stable and should be around for a bit, but you never know.

On timing of taxes, I am currently at the highest tax bracket so that's why I'm considering this. The only danger I see if I choose to work at a different company, after I leave, and unintentionally get doubled paid and I pay more taxes, but there is an option of deferring the starting payment date of 5 and 10 years.

 

[2B]

I have a SERP which is the same thing you are being offerred except I had to pick my distribution plan when I signed up. Somehow, I had the opinion that I could change this later but it turns out that if I change anything it delays the payout 5 years. I'm not willing to do that so I'm stuck with a very large payout next year when I retire.

To avoid having it all taxed at 33%, I have to retire early in the year. Even then, I'm going to get my marginal rate into the lower end of the 33% bracket. That's higher than my normal tax rate. When I realized this, I switched to the 5 year payout for a year but realized that these payouts would be taxed at the marginal 25% bracket so I stopped completely. The point of my tale is to have you make sure that you plan for what your tax brackets may be when you start getting payouts.

MooreBonds is correct in that SS and medicare are taken out in the year that contributions are made. I receive a matching contribution from the company (8%) but give up my company's 401k contribution of 5% of that portion of my salary. Every year when this vests, a SS deduction is taken out of my paycheck. This means I won't get hit with SS for this match after I retire. It's also meaningless since I payoff the SS max amount anyway. I just get hit with a big chunk at one time and have payroll deductions end a bit sooner.

Knowing what I know now, I would have either put my money in originally with a 5 year payout or just paid the taxes then and invested after tax where I could claim capital gains. If you will get $150k from the plan, you will be right on the edge of the 28% tax bracket without any other income. You also should factor in what you might expect in gains if you haven't already.

 

[papadad111]

The other issue aside taxation with sheltered or deferred comp plans is that the compensation counts against any ACA credits that you might otherwise be eligible for.

I will bet ACA did not exist when you signed up for the distribution elections. Now you could be facing higher tax and loss of ACA credits for several years while the deferred comp is paid out.

 

[woodguy00]

http://www.early-retirement.org/forums/f28/deferred-compensation-72357.html

I started the thread above and received some good advice from a few members. I did elect to defer 100% of bonuses going forward and look forward to some nice payouts over time at a reduced tax rate. While not at the top tax rate now, the tax savings were better than the additional cost of not qualifying for subsidized Obamacare

At the tax rate you are currently at and if you are confident of the long term prospects of your company, it seems like a very good opportunity with little if any downside.

 

[savory]

I was able to defer my bonuses at my megacorp. The division I worked for in this 100 year old company went through bad times. I did lose some sleep worried about losing my money. (My deferral was treated as an unsecured loan. Perhaps they all are treated this way?) They sold the division and the new company has provided me more confidence. Plus, my payoff has started. I was not as good of a planner at the time (should have done what you are doing) and expect to get hit by higher taxes than I needed to for about 4 years since my payout will overlap my SS payout. This primarily is the result of planning to take SS at 66 vs. 70 after learning about the apply and suspend payment program. I still need to finish the analysis on this but I am fairly certain on a total cash flow basis, I will be ahead to take SS at 66 even after paying higher taxes. The great news was during the recent market downturn, my deferred bonus just kept delivering nice returns as the company honored its loan agreement. It was a very bright spot in a bad time. I think I would do it again but it does come with some worry.

 

[2B]

The division I worked for in this 100 year old company went through bad times. I did lose some sleep worried about losing my money. (My deferral was treated as an unsecured loan. Perhaps they all are treated this way?)

I was working on a project with a very old company (not an employee) that got acquired by another company. The acquiring company was heavily leveraged and went under in 2010. I ended up hearing about several managers that lost hundreds of thousands of dollars in the collapse. The company I work for lost a bunch of money for engineering services. I didn't have to give back any of my pay.

Being an unsecured creditor is not a nice feeling especially if you start to smell any sort of financial problems. It reminds me of the engineer that was working as a FA during the peak Enron days. He had this client that had several million dollars in Enron stock but couldn't touch it as long as he was an employee. The FA asked him what he really wanted to do and how much it would cost to do that. The guy wanted to move back to the small Ohio town he was from and either retire or get a part time job. The millions easily covered his goals. He quit Enron less than a year before the collapse and moved into diversified index funds. I met the FA when he was back into engineering and he said the guy sent him the nicest thank you note he'd ever seen.

 

[Toocold]

I started the thread above and received some good advice from a few members. I did elect to defer 100% of bonuses going forward and look forward to some nice payouts over time at a reduced tax rate. While not at the top tax rate now, the tax savings were better than the additional cost of not qualifying for subsidized Obamacare

Thanks for sending this link and sharing with me what you chose to do. Great trove of information.

 

[woodguy00]

There was another discussion about a month earlier than the thread I started that also had a bunch of good info also. I just can't find it right now.

 

[rb35]

I'm glad you started this topic as I'm considering doing the same. A couple of points I found useful in my analysis:

1. When I compared the tax benefit of deferring money at the highest marginal tax bracket now versus my projected effective tax rate in the future, I would need to invest the after tax money now and outperform the investments in the deferred compensation plan by about 4% a year for 10 years to break even.

Stated another way, the investments in the deferred compensation plan would have to be truly horrible to underperform by 4% a year over 10 years.

2. I need to do more analysis, but I've considered buying deep out of the money equity puts on my company to hedge out credit risk. In the tail scenario where you get wiped out as a creditor, the equity would be toast first.


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[rb35]

Has anyone signed up to www.mynqdc.com ? It discusses non-qualified deferred compensation plans.

Wondering if it's worth the 200 / year subscription price.


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