Should I defer compensation?

[scooter260]

For the first time in my career, I am being offered the flexibility to defer compensation and I am struggling to determine if I should or not. I can defer up to 90% of my bonus and restricted stock amounts. I expect my cash bonus will be in the $65k range.

I know the key benefit of deferring is to postpone the payment of federal and state income taxes and deferred compensation is invested on a pre-tax basis (similar to 401(k) plans).

I can defer for at least 2 years and I must collect the full amount by age 70. I have the option to collect in a lump sum or in equal amounts over a 10 year (or less) period. I cannot change my choice after election; however, I can shift the withdrawal date at least 5 years ahead, if desired.

If I don't need the money today, is this a no-brainer to defer? I am 36 years old. My thinking is to defer for 5 years and then re-assess. If I still don't need the money at that time, I will just push it back another 5 years.

I don't have any clue as to what to do with the Restricted Stock portion.

TIA!

 

[jwkde]

Is it considered a "qualified" or "non-qualified plan". Sounds like a "non-qualified plan from your description.

Funds in a non-qual plan are normally assets of the company and you are in line as a creditor in case of financial issues of the company. In that case, you need to consider the longer term viability of the company.

 

[SunsetSail]

Some things to consider:
- Deferred comp plans are non-qualified so if the company folds you could be out of luck
- You are pretty young so if you leave the company and have to take the comp out you could end up pushing yourself into a higher tax bracket. You may be in a higher tax bracket with higher income in later years so you would lose some benefit.
- You didn't mention how much the comp earns - it is typically a fixed amount based on prevailing interest rates
I have always declined def. comp options because I wanted control of the money. The tax benefits and return weren't enough to justify trusting someone else with it. I think it might make more sense if you plan to retire and reduce your marginal income tax rate in the next five or so years, but you need to run the individual numbers and scenarios.

By definition you probably can't do anything with the restricted stock until the holding period is up.

 

[FIREd]

If you defer your cash bonus, do you earn interests on that money? What tax bracket are you in currently?

Personally, I always take the cash bonuses but I sometimes defer some of the stock.

 

[Rich_by_the_Bay]

SunsetSail covers the issues I had to address (with a private 457 plan). In addition, a) the deferred comp funds - assuming it is a private plan - may be vulnerable if your company goes bust down the road and b) when you take distributions you may be liable for Medicare contributions in the year of the distribution.

Still, it's a good deal if the above cautions are considered acceptable. Definitely max out your qualified plans first.

 

[Meadbh]

I expect my cash bonus will be in the $65k range.

Your bonus = my salary (I do have other earnings).
I would take the money and run.
A bird in the hand is worth two in the bush!

 

[scooter260]

There are 7 investment options I could choose ranging from safe (US Treasury's) to riskier (domestic and international stocks). My wife and I file jointly and we will be in the 35% bracket in 2010 and likely stay in the highest bracket from here on out. I have an extremely high level of confidence that my company (S&P 500, 125 years old and strong) will remain solvent....I realize that anything can happen, but I don't think we will be in any trouble.

Does this change anyone's recommendation?

 

[SunsetSail]

There are 7 investment options I could choose ranging from safe (US Treasury's) to riskier (domestic and international stocks). My wife and I file jointly and we will be in the 35% bracket in 2010 and likely stay in the highest bracket from here on out. I have an extremely high level of confidence that my company (S&P 500, 125 years old and strong) will remain solvent....I realize that anything can happen, but I don't think we will be in any trouble.

Does this change anyone's recommendation?

It makes the def. comp look more attractive (you can work it into your regular asset allocation), but you really just need to set up some spreadsheets and map the scenarios out in terms of numbers. The bottom line will be whether you are willing to accept the added risk (small in your opinion) of deferral for the earnings you receive on the amount of tax deferred. I haven't checked in years, but I believe that you will convert capital gains and dividends into ordinary income for tax purposes within the def. comp vehicle so that may be a consideration of what type of investment to pick.

You should also consider the uncertainty about future tax brackets and whether there will be supplemental taxes (e.g., medicare on the amounts you earn over $250K). This may be an argument pro or con depending on the structure and length of the tax. You can only model what ifs here.

I still prefer to get the money now unless I was going to retire before the pay out period and I was planning on most income from a relatively tax efficient portfolio for the pay out period. However, the numbers may work out that it make sense for you to defer.