Join Early Retirement Today
Reply
 
Thread Tools Display Modes
Deferred Compensation -- how to use it to RE sooner
Old 06-02-2021, 09:47 PM   #1
Dryer sheet aficionado
 
Join Date: May 2019
Posts: 26
Deferred Compensation -- how to use it to RE sooner

I just got a promotion at work and that makes me freshly eligible to participate in employer provided Deferred Compensation program. I am able to defer up to 75% of my salary and up to 100% of my yearly bonus, both pre-tax (part of the "deferring" is to defer paying taxes). The deferred amount is invested in funds (haven't fully consumed the program specifics yet), and can be disbursed at a future date over N years, typically when one has retired and hence is on a lower tax bracket. This disbursement schedule has to be chosen well in advance (at the time of deferral) and cannot be easily changed.

At max, I am able to defer up to ~200K this way per year. Of course, the risk is this is basically an unsecured loan to my employer from me. The employer is a super-megacorp that I believe should be around in the next 10 years when I plan to retire (knock on wood, just in case). This program would help me, because lets just say that the Biden tax (>400K) has already started biting me hard - so this deferral will help me reduce my taxable income dramatically below that line.

My yearly spend (incl. mortgage, medical thru employer) is 90k. I want to leave enough in my base to max out 401k (both pre-tax and the post-tax max). I can sell my vesting RSUs (stocks) to make cash to live on.

I would appreciate any advice from folks familiar with such plans, who actually used such a plan to RRE (Retire Really Early). I didn't find any calculators online for this plan, and doing some research it seems like it requires professional services to properly plan. Hoping the great community here can help me prepare better. Thanks in advance!
lionfire is offline   Reply With Quote
Join the #1 Early Retirement and Financial Independence Forum Today - It's Totally Free!

Are you planning to be financially independent as early as possible so you can live life on your own terms? Discuss successful investing strategies, asset allocation models, tax strategies and other related topics in our online forum community. Our members range from young folks just starting their journey to financial independence, military retirees and even multimillionaires. No matter where you fit in you'll find that Early-Retirement.org is a great community to join. Best of all it's totally FREE!

You are currently viewing our boards as a guest so you have limited access to our community. Please take the time to register and you will gain a lot of great new features including; the ability to participate in discussions, network with our members, see fewer ads, upload photographs, create a retirement blog, send private messages and so much, much more!

Old 06-03-2021, 12:33 AM   #2
Full time employment: Posting here.
 
Join Date: Jul 2014
Posts: 860
If Megacorp stays solvent and the "investment" choices are good, this can work out very well - it has for us. Of course, if Megacorp goes bankrupt....

Assuming you have a similar Non-Qualified Deferred Compensation (NQDC) plan, there is no money invested for you. You get a promise from Megacorp to pay you later "as if" the money had been invested in the funds you choose.

If you choose a payout length of at least 10 years, the state you resided in when you earned the deferred compensation can't tax you on amounts you receive if you no longer reside there.

Read the fine print, understand the risk/reward picture, and good luck!
SevenUp is online now   Reply With Quote
Old 06-03-2021, 05:03 AM   #3
Thinks s/he gets paid by the post
 
Join Date: Jul 2011
Posts: 1,282
Good news- I used it as a bridge to SS. The deferred income along with. pension allowed me to retire at 54. I got tax lucky because I miss calculated the length of time for the payments as it related to SS but then they moved SS to 72. The point is to be careful as during the time I was receiving distributions, the rules changed so the end date could not be changed.

Bad News - so now, I am receiving a mostly worry free income flow from pension and deferred bonus. SS will replace Deffered bonus. However IRA conversations and/or distribution is a significant tax hit. I could have looked more carefully at conversion strategy.

Having said that, between pension and deferred bonus my lifestyle is adequately taken care of. I only have a few years of deferral left but it’s tax free performance meet my goal and SS will be a perfect bridge. My IRA conversion to Roth will result in a higher tax rate which I wish I worked on earlier. All in all, it has worked very well for me.
savory is offline   Reply With Quote
Old 06-03-2021, 06:20 AM   #4
Thinks s/he gets paid by the post
 
Join Date: Mar 2011
Location: North TX
Posts: 1,800
We used this to fund 3 years of very low income years living in Mexico. Would have paid CA taxes on the $$. Before Mexico, we moved to Dallas. Saved a bundle on state taxes and fed too as we were in the 30+% rate at the time. Basically saved 30-40% while in Mexico & were earning a pittance there.

Based on your numbers, I'd go with a longer payout period (we only had a 5 or 10 year option). We personally had a plan & did the 5 year option. Worked out perfectly for us...
Surewhitey is offline   Reply With Quote
Old 06-03-2021, 06:31 AM   #5
Thinks s/he gets paid by the post
 
Join Date: Mar 2014
Location: Dallas
Posts: 1,150
I was offered a differed compensation plan this year. As someone mentioned, the biggest risk is solvency and fund choices. Fortunately my mega-corp had an index fund with a very little expense ratio (0.01%) so I choose to use the plan. I wouldn't contribute too much but enough to jump the tax bracket and fill the bridge years. You will have to hedge your bets since the tax savings is substantial but so is the principal risk. Remember: You company has to survive until you leave plus your distribution years which can be a very long time.

FWIW I ended up differing about 20% with a 10 year distribution period.

PS: Another big risk that is often not talked about. What if you have to change your job before your retire? This would hit you with a lot of taxes (exact opposite of what you planned for) since the differed comp will start as soon as to leave your current company. There is a reason this plan is called golden handcuffs.
pjigar is online now   Reply With Quote
Old 06-03-2021, 08:47 AM   #6
Recycles dryer sheets
Lagniappe's Avatar
 
Join Date: Mar 2006
Posts: 406
I used Deferred Comp to provide an income stream for the first ten years of retirement. I am in year 3 of that plan, and so far it is going fine.

I avoided paying 10% income tax in the state I was living in since I moved to Florida full time after retirement, plus my marginal rate is much lower now.

Don't forget that your company is paying out based on your selected investment returns, so the income can vary significantly from year to year in a volatile market.

Two things I should have considered but didn't- the impact on health insurance subsidies and the impact on Roth conversions. The market has gone up a lot the last three years, and because of these increased payouts I am not eligible for any ACA subsidies. But these are good problems to have, so I am not complaining.

One final concern - not every tax preparer is familiar with Deferred Comp. I found that I was paying for their time to research how to handle my taxes.
Lagniappe is online now   Reply With Quote
Old 06-03-2021, 08:59 AM   #7
Full time employment: Posting here.
 
Join Date: Jun 2014
Posts: 518
This is similar to the strategy that I used to help bridge my RE income. My choice was payout over 1 year, 5 years, or 10 years. To make the math easy to understand, I deferred 1M over 10 years and .5M over 5 years, and I deferred the 10 year payout by 5 years. This allowed me to bridge payments so that I got paid $100k over 15 years from 50 to 65.

Besides the issue of solvency, I faced another issue. When I left I had approximately 15 months of severance and substantial SARs vested that I had to exercise over 2 years. This resulted being in the highest marginal tax bracket the first two years, so during the first two years, I had little tax savings from pursuing the NQDC path. So far, so good, and my megacorp remains strong.

Also, while the payments are considered W-2, you can't put them in a pre-tax traditional IRA. I do plan to use the backdoor roth for additional tax optimization.
Toocold is offline   Reply With Quote
Old 06-03-2021, 10:28 AM   #8
Thinks s/he gets paid by the post
RockyMtn's Avatar
 
Join Date: Jul 2009
Location: North Scottsdale
Posts: 1,545
I too went the deferred comp route on a portion of my bonus and earnings. As others have noted this can be a very attractive option although you need to be careful that a confluence of factors doesn't end up wiping out all of the incentive to defer in the first place.

Once I retired the deferred comp started to kick in...part of the deal....right at the time I converted a sizable 401K to and IRA so that I could begin Roth conversions. Then some final stock options vested and I received an inherited IRA that I had to take RMD's on. Next thing I know I'm paying higher tax rates than I had planned basically wiping out any benefit from deferring the comp in the first place.

I was able to get the ship righted but have not been able to draw down the IRA to Roth conversions as quickly as I had planned. Hopefully by delaying SS to 70, RMD's on what's left in the IRA until 72 and managing dividends by going muni route will make the tax situation more palatable.

Probably wouldn't have gone to the level on the deferred comp that I did had I thought it through a bit more. Just some thoughts...YMMV. Good luck!
__________________
FIRE'D in July 2009 at 51...Never look back!
RockyMtn is offline   Reply With Quote
Old 06-03-2021, 11:36 AM   #9
Thinks s/he gets paid by the post
 
Join Date: Oct 2013
Posts: 1,181
I was offered a deferred comp plan from MegaCorp but declined. I didn't trust that MegaCorp would be around when I retired, at least in it's current form, and the fund choices and expense ratios weren't well defined. HR was no help and basically clueless. Instead, I chose to add to my after tax stash invested 100% in stocks in low cost funds, and so far, I'm happy with that decision.
freedomatlast is online now   Reply With Quote
Old 06-03-2021, 09:30 PM   #10
Dryer sheet aficionado
 
Join Date: May 2019
Posts: 26
Thanks so much for the inputs! Great to know it worked well for most folks, although it seems like a general pattern that taking MAXIMUM advantage of the tax reduction is a hit-or-miss even with lots of planning - just seems like too many factors that can impact it. It does give me things to investigate (RMDs, SS delaying, any stock award vesting post-retirement, other income (inheritance? may not count), etc.). I do plan on consulting my CPA and investment advisors before deferring compensation (I have a few months before I have to decide for next year), will circle back here if I hear any interesting advice.

One question for folks who said the tax benefits were not "as much" - isn't the fact that the deferred $$ grew tax-free for many years a big advantage, even if u end up paying taxes on it (capital + gains) eventually? Or was it still not worth it somehow? I (maybe naively) see deferred compensation as a "pretax 401k with no ceiling" option... which makes it super-sweet... no? (ignoring the creditor risk and all that for a min)
lionfire is offline   Reply With Quote
Old 06-03-2021, 10:35 PM   #11
Recycles dryer sheets
 
Join Date: Oct 2008
Posts: 131
What happens if you leave the company prior to retirement? For example, when I left my employer, the deferred compensation payments came immediately and on top of other end of employment payments (i.e., option exercises) and my salary at my new job. Fortunately, I had not deferred that much compensation but there were no tax savings.
YMMV but under my employer's plan, a big deferral of income would make sense if I was sure that it was my last job and that the Company would continue to employ me until I was ready to retire. Dare I say, that doesn't always happen.
These megacorp jobs have lifespans which may or may line up with your long term goals. I'd suggest that you understand how this will work if you and/or your employer wants to move on before you are ready to retire and see if that fits your plan.
Good luck!
BR
bigreader is offline   Reply With Quote
Old 06-03-2021, 11:01 PM   #12
Full time employment: Posting here.
 
Join Date: Jul 2014
Posts: 860
Quote:
Originally Posted by lionfire View Post
One question for folks who said the tax benefits were not "as much" - isn't the fact that the deferred $$ grew tax-free for many years a big advantage, even if u end up paying taxes on it (capital + gains) eventually? Or was it still not worth it somehow? I (maybe naively) see deferred compensation as a "pretax 401k with no ceiling" option... which makes it super-sweet... no?
The sweetness or sourness will be the same as with any traditional (aka pre-tax) contribution: sweet if withdrawn at a marginal tax rate less than the marginal tax rate saved at contribution, but sour if the withdrawal tax rate is higher than the contribution one. See Traditional versus Roth - Bogleheads.
SevenUp is online now   Reply With Quote
Old 06-03-2021, 11:02 PM   #13
Full time employment: Posting here.
FlaGator's Avatar
 
Join Date: Aug 2008
Location: The 850
Posts: 970
Quote:
Originally Posted by lionfire View Post
Thanks so much for the inputs! Great to know it worked well for most folks, although it seems like a general pattern that taking MAXIMUM advantage of the tax reduction is a hit-or-miss even with lots of planning - just seems like too many factors that can impact it. It does give me things to investigate (RMDs, SS delaying, any stock award vesting post-retirement, other income (inheritance? may not count), etc.). I do plan on consulting my CPA and investment advisors before deferring compensation (I have a few months before I have to decide for next year), will circle back here if I hear any interesting advice.

One question for folks who said the tax benefits were not "as much" - isn't the fact that the deferred $$ grew tax-free for many years a big advantage, even if u end up paying taxes on it (capital + gains) eventually? Or was it still not worth it somehow? I (maybe naively) see deferred compensation as a "pretax 401k with no ceiling" option... which makes it super-sweet... no? (ignoring the creditor risk and all that for a min)
Congratulations on the career success that gave you this opportunity!

While I took advantage of a DC plan, don't think I'd do it again.

I participated for a few years, and selected a short term for payout (<= 5 years) and then stupidly put 100% in equities. Got hit by a lucky stick, though - the market was rising the entire time. Once I figured out my idiocy, I throttled back, just ahead of the 2008-09 meltdown. In the end, I earned enough to pay all the taxes, so I ended up with the full amount of the initial deferrals. After the initial years of deferrals, declined to participate due to increasing uncertainty of the future of the company and my prospects (both proved to be unfounded). Also didn't like giving up/locking up money I had legitimately earned but no longer controlled.

With that experience, I advise the following:
1. If you are *certain* your tax rate will be lower, when the money comes out, it's a decent deal.
2. Look closely at your investment options. Most of these plans are run by annuity/life companies and the investment options may not be good. High expenses and active management resulted in low returns in my plan.
3. Be thoughtful about your holding period, and understand what happens if you separate early.
4. When DC money comes out, it is taxed at ordinary income rates, so you give up capital gain tax treatment compared to investing on your own.
5. An alternative to participating is to pay the taxes now, invest the money as you see fit and retain control of the timing of distributions/access, investment costs, etc. Yeah, may cost a bit, but that kind of control has value.
__________________
Stay at home slacker dad 2015-August 2024. With the last kid gone, now actually retired
FlaGator is offline   Reply With Quote
Old 06-04-2021, 06:06 AM   #14
gone traveling
 
Join Date: Aug 2020
Posts: 682
NQPs are good. I would participate to the fullest extent possible after contributing to 401k to receive employer match, if offered, and after college education for children is funded, if this applies to you.

I would elect a long payout/distribution period upon separation or termination.

The investment choices in a plan I participated in had very few investment choices, but one of them was very good, and I concentrated all holdings in the NQP into this investment.

Regarding RRE, use portfoliovisualizer. Professional planning help is not needed. The “Financial Goals” option in portfoliovisualizer allows you to enter individual cash flows. It’s a very good model, give it a test drive.

I would treat NQP like 401k - it’s pretax money and grows according to the market.

No model or calculator that I have found so far handles tax scenarios well. So focus on net worth (including NQP), living expenses, SS and other income. I built my own model to study tax impacts. Complex but you learn a lot when building the model.
chassis is offline   Reply With Quote
Old 06-09-2021, 06:48 AM   #15
Thinks s/he gets paid by the post
 
Join Date: Mar 2011
Location: North TX
Posts: 1,800
Quote:
Originally Posted by bigreader View Post
What happens if you leave the company prior to retirement? For example, when I left my employer, the deferred compensation payments came immediately and on top of other end of employment payments (i.e., option exercises) and my salary at my new job. Fortunately, I had not deferred that much compensation but there were no tax savings.
YMMV but under my employer's plan, a big deferral of income would make sense if I was sure that it was my last job and that the Company would continue to employ me until I was ready to retire. Dare I say, that doesn't always happen.
These megacorp jobs have lifespans which may or may line up with your long term goals. I'd suggest that you understand how this will work if you and/or your employer wants to move on before you are ready to retire and see if that fits your plan.
Good luck!
BR
You leave, you get paid. Pretty sure that you cannot rollover it to an IRA. Not a great idea if you are not taking time off or truly retiring.

Another snafu that happened to us is they did something incorrectly as to eligibility for one year and had to write us a massive check due to the mistake. As I recall, they bumped it up to pay for the penalty /taxes we were out. Weird how an international insurance company did not have the knowledge of the rules of this.
Surewhitey is offline   Reply With Quote
Reply


Currently Active Users Viewing This Thread: 1 (0 members and 1 guests)
 
Thread Tools
Display Modes

Posting Rules
You may not post new threads
You may not post replies
You may not post attachments
You may not edit your posts

BB code is On
Smilies are On
[IMG] code is On
HTML code is Off
Trackbacks are Off
Pingbacks are Off
Refbacks are Off


Similar Threads
Thread Thread Starter Forum Replies Last Post
Deferred Compensation Savings Plan Willers FIRE and Money 35 06-02-2014 11:05 AM
Deferred compensation for small business owners? someguy FIRE and Money 17 04-12-2014 11:46 AM
Deferred Compensation and Early Soc Sec 4th&Goal FIRE and Money 3 11-30-2007 07:18 PM
Deferred Compensation anonymous_fred FIRE and Money 16 11-04-2007 10:36 AM
Asset Allocation Question - Deferred Compensation b3bobster FIRE and Money 1 11-06-2006 03:51 PM

» Quick Links

 
All times are GMT -6. The time now is 06:18 PM.
 
Powered by vBulletin® Version 3.8.8 Beta 1
Copyright ©2000 - 2024, vBulletin Solutions, Inc.