Deferred Compensation

[anonymous_fred]

Thanks to a promotion at work, my wife now qualifies for a deferred compensation plan, and we are trying to figure out how best to take advantage of it. I'm curious to hear from others who are utilizing deferred compensation for tax engineering.

Her employer gives her the opportunity to defer up to 50% of her salary, and her entire bonus (which is generally about 25% of her salary). She can choose any year at least 3 years in the future to start receiving distributions from a given year's deferred compensation. She can choose to receive the distribution as a lump sum, over 5 years, or over 10 years. Each year she can change the elections for the following year's compensation.

We are currently paying approximately 42% marginal state + federal tax, and we can afford to live off my salary, so it is feasible to defer the maximum allowed. We are both in our very early 30s, and are planning to retire somewhere around age 40.

We have a few concerns; some legitimate and some less so. That's why I'm curious to hear from others participating in similar programs.

* If we defer too much, then when we are forced to receive distributions we may wind up not reaping much tax benefit.

* The deferred compensation goes into a NQRP, which is not protected from creditors. Her employer is a very profitable company, so insolvency is unlikely. But it's always possible.

And a couple questions

* If we move to a lower-tax state after retirement, can our current (high tax) state come after us for taxes on income earned, but deferred, while we were living here?

* Anyone aware of downsides to a program like this? It seems to me like a tremendous "step function" from the retirement others at her company are offered (which is pretty much just 401k and profit sharing). Are we missing some big "gotcha"?


I'd appreciate any insights.. Thanks!

Anonymous_Fred

[perinova]

I don't know anything about that but I would like to know more.
I googled NQRP and didn't find any match, I am guessing it is Non Qual Retrt Plan.

It brings up questions:
Does it mean that the company writes off the compensation the current year? When does the FICA tax apply and soc. security earnings granted? What happens to W2s?

Is there a site where information can be found?

[MileKing]

Quote:

Originally Posted by anonymous_fred * If we move to a lower-tax state after retirement, can our current (high tax) state come after us for taxes on income earned, but deferred, while we were living here?Anonymous_Fred

No, provided you meet certain distribution requirements. This link provides some background:

White & Case LLP - Publications - NY Acts on Taxation of Nonresident Retirement Income, While Recently-enacted Federal Legislation Prohibits States from Taxing Retirement Income of Nonresident Partners

[saluki9]

I have dealt with many of these plans.

The first thing to consider is the financial health of her company. Remember that in order to keep their deferred status, these assets can't be segregated from the company assets. Therefor, if the company goes under, you can lose some or all of the assets in the deferred comp plan.

Once that is met, there are other thing to consider like whether the plan is funded or unfunded, etc.

[anonymous_fred]

Quote:

Originally Posted by perinova I don't know anything about that but I would like to know more. I googled NQRP and didn't find any match, I am guessing it is Non Qual Retrt Plan. It brings up questions: Does it mean that the company writes off the compensation the current year? When does the FICA tax apply and soc. security earnings granted? What happens to W2s? Is there a site where information can be found?

Hi Perinova,

By "NQRP" I mean "non-qualified retirement plan". See for example Retirement Plan Primer [Fool.com: Retirement Planning]

The company does not get to write off the compensation until it is paid. My understanding is that her W-2 will reflect only the *non-deferred* portion of her income. SS/Medicare tax is an interesting question; I'm not sure if that is assessed on the entire pay, or only on the non-deferred pay. I suspect the latter.

[anonymous_fred]

Thanks for the information MileKing and saluki.

The company is extremely profitable and participates in a high margin industry. I probably shouldn't be worried about solvency (though of course I always am

The whitecase article is interesting. It looks like we need to find out if the clause:
the source tax law also applies to payments received after termination of employment under a nonqualified deferred compensation plan "maintained solely for the purpose of providing retirement benefits to employees in excess of the limitations imposed by 1 or more of sections 401(a)(17), 401(k), 401(m), 402(g), 403(b), 408(k) or 415 of [the] Code on plans to which any of such sections apply."

applies to this plan...



Thanks!
Anonymous_Fred

[RetireeRobert]

Quote:

Originally Posted by anonymous_fred Hi Perinova, By "NQRP" I mean "non-qualified retirement plan". See for example Retirement Plan Primer [Fool.com: Retirement Planning] The company does not get to write off the compensation until it is paid. My understanding is that her W-2 will reflect only the *non-deferred* portion of her income. SS/Medicare tax is an interesting question; I'm not sure if that is assessed on the entire pay, or only on the non-deferred pay. I suspect the latter.

I am not at all sure, but I would have a concern about the "Non-qualified" nature of the plan meaning that the earnings within the plan do not accumulate on a tax-deferred basis. In other words, a taxable account funded with before tax dollars.

Probably not, but I think I would verify to make sure the account pot also earns on a tax-deferred basis as well.

[anonymous_fred]

Quote:

Originally Posted by RetireeRobert I am not at all sure, but I would have a concern about the "Non-qualified" nature of the plan meaning that the earnings within the plan do not accumulate on a tax-deferred basis. In other words, a taxable account funded with before tax dollars. Probably not, but I think I would verify to make sure the account pot also earns on a tax-deferred basis as well.

My understanding is that the 'non-qualified' basically means that the company does not receive preferential tax treatment for the plan.

That allows it to be offered on a 'discriminatory' basis. In other words, it doesn't have to be offered to all employees.


I'm sure the details are more complex, but I've basically viewed it as an agreement between the employer and employee that the employee will effectively take a pay cut for now, with the promise that at a later date the employer will keep paying the employee, even though the employee is no longer doing any real work. The amount and timing of the future pay is based on the employee's current elections.

Of course that means that in the future, all the "deferred" pay is subject to income tax.


Anonymous_Fred

[Puzzley]

I have been enrolled in a non-qualified deferred compensation plan with a Major US company for many years, and for me, it has been the real key to FIRE. The def comp does, indeed, grow in a tax-deferred account. However, a few years ago, a federal change required them to start withholding medicare on the entire amount immediately. I have elected to have mine paid to me over a 5 year period beginning in 2010, but in reality, the plan rules require the 5 year distribution to start on March 1 following the date I leave the company, without regard to the reason, so for me, the first payment will be March 1, 2009. When I first set this up, I determined that I would definately be retired before 2010. Be careful here, because your elections are NOT changeable. If you found that your retirement date would have to be pushed beyond the date the payments are slated to begin, they will begin whether or not you have retired. If the plan works like mine, and I'd wager it does, just set the payments up for far in the future, and then it'll be there as soon as you retire.

It is my understanding that the payments will be taxed as ordinary income, just as if it were a salary, since it's funded with before tax dollars and you will be issued a w-2.

I would recommend that you seriously consider it, as it's a great retirement savings vehicle.

[SkiFIRE]

I've also been in a plan very similar to this, and it has been a *major* wealth-building vehicle. In my megacorp's plan (YMMV) the money grows tax-deferred until distribution. Payroll tax is deducted at the time you contribute into the fund, and no payroll tax is due on the distributions, even on investment returns. Another aspect of this plan - very attractive - is that my megacorp contributes "excess" profit sharing (ie: money above IRS limits for 401K contributions) into the deferred comp plan.

I seriously doubt I would be about to FIRE (in January!) without having committed to this plan, it has kept me from touching a dime from my annual bonus compensation for many years now, and it will be my base income layer for the next 10 years. Combined with dividends, I've got a reasonable chance of not tapping any other assets until 2019 or so...

The key risk here is indeed the fact that this is an unsecured corporate debt. Take a hard look at the corporate balance sheet, and reputation for quality of corporate governance. In my megacorp's case, rock solid on both counts - and I deemed the risk that things would go dramatically south to be low enough that I would sleep at night.

[ExtinctBird]

How might these deferred comp plans be affected if your megacorp gets bought out? Do you have any protection against the new mega-megacorp?

[Puzzley]

Quote:

Originally Posted by ExtinctBird How might these deferred comp plans be affected if your megacorp gets bought out? Do you have any protection against the new mega-megacorp?

None that I'm aware of.... that's one of the risks. However in my personal sitation, my megacorp is so mega that it would be a tough nut to swallow for any other corp in it's field.

[FinanceGeek]

My experience with these plans is not as favorable as others have reported. Beware the high fees and limited investment choices!

[Delawaredave5]

Generally, what are the investment choices ? Are they generally the same as a company's 401K options ?

[SkiFIRE]

At least in the case of the plan I'm in, there are no fees at all, other than the generally very low negotiated expenses on the investment choices, which are exactly the same as those in our 401K.

[Puzzley]

Quote:

Originally Posted by FinanceGeek My experience with these plans is not as favorable as others have reported. Beware the high fees and limited investment choices!

High fees? My experience has been no fees at all.... Investment choices about the same as our 401(k)

Limited choices and fees may be associated with a particular company...

[anonymous_fred]

Similar to other comments, my wife's plan has no fees and offers choices identical to her 401k. The 401k includes a wide variety of highly regarded funds from Vanguard and Fidelity (including index funds, which would likely be her choice).


Anonymous_Fred