Modeling Deferred Comp Payout

[Closet_Gamer]

OK, for all the modeling gurus out there...curious how you would model the following...

I have a tidy sum (and a large fraction of my net worth) in a deferred compensation plan. In all likelihood, the money will pay out before I ER and while I still have other income coming in. I intend 100% of this money to be pointed toward retirement.

This makes modeling complicated in two dimensions:

1) How do I think of this money in terms of retirement "assets"? As the money will need to flow through the income tax system, and I can't just hold it off until RMDs kick in like an IRA, it doesn't seem right to score 100% of the value as a retirement asset (e.g., I can't just do a SWR % against the gross value of the money). I think it has to get marked down to the likely after-tax value because it will come out in large chunks ($150K+/yr)

2) What tax rate should I use for the mark down? I don't know how much I'll be earning in the years this money comes out, but hopefully its a good amount. So when I reduce the gross value of the deferred comp by the likely tax load, should I treat all of the deferred comp as though it comes out "on top" of my earnings for those years? That would imply marginal rates >35-45%. Or should I think of that money as the first dollars that come out and then "stack" my earned income on top of that (implying that I would pay a higher effective rate on the earned income but would "keep" more of the deferred comp in my retirement assets.)

My current approach is:

1) Mark down the value to an after-tax amount for modeling purposes

2) Treat the deferred comp as the "last dollars earned" and assume a 40% tax hit to the deferred comp as it pays out

Am curious how others would think about this.

Thanks.

[pb4uski]

I think i would do it as you are. Convert it to an after-tax amount using the expected marginal tax rates and include that as a taxable account asset in your retirement projections.

The other approach would be to include it pre-tax and include special expenses in the years you expect to receive it for the tax bite.

Six of one... half dozen of another.

[Closet_Gamer]

Quote:

Originally Posted by pb4uski I think i would do it as you are. Convert it to an after-tax amount using the expected marginal tax rates and include that as a taxable account asset in your retirement projections. The other approach would be to include it pre-tax and include special expenses in the years you expect to receive it for the tax bite. Six of one... half dozen of another.

Thanks. I hadn't considered that option. To your point, math nets out the same.

[robertf57]

Quote:

Originally Posted by krotoole OK, for all the modeling gurus out there...curious how you would model the following... I have a tidy sum (and a large fraction of my net worth) in a deferred compensation plan. In all likelihood, the money will pay out before I ER and while I still have other income coming in. I intend 100% of this money to be pointed toward retirement. This makes modeling complicated in two dimensions: 1) How do I think of this money in terms of retirement "assets"? As the money will need to flow through the income tax system, and I can't just hold it off until RMDs kick in like an IRA, it doesn't seem right to score 100% of the value as a retirement asset (e.g., I can't just do a SWR % against the gross value of the money). I think it has to get marked down to the likely after-tax value because it will come out in large chunks ($150K+/yr) 2) What tax rate should I use for the mark down? I don't know how much I'll be earning in the years this money comes out, but hopefully its a good amount. So when I reduce the gross value of the deferred comp by the likely tax load, should I treat all of the deferred comp as though it comes out "on top" of my earnings for those years? That would imply marginal rates >35-45%. Or should I think of that money as the first dollars that come out and then "stack" my earned income on top of that (implying that I would pay a higher effective rate on the earned income but would "keep" more of the deferred comp in my retirement assets.) My current approach is: 1) Mark down the value to an after-tax amount for modeling purposes 2) Treat the deferred comp as the "last dollars earned" and assume a 40% tax hit to the deferred comp as it pays out Am curious how others would think about this. Thanks.

Well,

First, I am a bit confused about your plan. Is this a 457 plan? Do you really need or want to take funds from it while you are still working? I personally consider my 457 plan like any other pre-tax retirement account; only with better withdrawal options. No any more complicated than that.

[hnzw_rui]

Quote:

Originally Posted by robertf57 First, I am a bit confused about your plan. Is this a 457 plan? Do you really need or want to take funds from it while you are still working? I personally consider my 457 plan like any other pre-tax retirement account; only with better withdrawal options. No any more complicated than that.

+1.

If you don't need the funds, delay withdrawals until needed. Unless, of course, you think you'll forever be in the highest tax bracket even upon retirement. Then, I'd just convert the entire sum to Roth.

[Big_Hitter]

I'm sure this is a NQDC plan (IRC 409A) - the OP has to elect the time (age 60/65 etc.) and form of payment (lump sum, 5 year term, etc.) before compensation is deferred; so generally, there is no decision to make regarding time or form of payment at this point


https://en.wikipedia.org/wiki/Intern...e_section_409A

[pb4uski]

That is what I suspected it is too given the significant amounts involved.

[big-papa]

Quote:

Originally Posted by krotoole OK, for all the modeling gurus out there...curious how you would model the following... I have a tidy sum (and a large fraction of my net worth) in a deferred compensation plan. In all likelihood, the money will pay out before I ER and while I still have other income coming in. I intend 100% of this money to be pointed toward retirement. This makes modeling complicated in two dimensions: 1) How do I think of this money in terms of retirement "assets"? As the money will need to flow through the income tax system, and I can't just hold it off until RMDs kick in like an IRA, it doesn't seem right to score 100% of the value as a retirement asset (e.g., I can't just do a SWR % against the gross value of the money). I think it has to get marked down to the likely after-tax value because it will come out in large chunks ($150K+/yr) 2) What tax rate should I use for the mark down? I don't know how much I'll be earning in the years this money comes out, but hopefully its a good amount. So when I reduce the gross value of the deferred comp by the likely tax load, should I treat all of the deferred comp as though it comes out "on top" of my earnings for those years? That would imply marginal rates >35-45%. Or should I think of that money as the first dollars that come out and then "stack" my earned income on top of that (implying that I would pay a higher effective rate on the earned income but would "keep" more of the deferred comp in my retirement assets.) My current approach is: 1) Mark down the value to an after-tax amount for modeling purposes 2) Treat the deferred comp as the "last dollars earned" and assume a 40% tax hit to the deferred comp as it pays out Am curious how others would think about this. Thanks.

What I do is closest to #1 above. But I also model transferring the after tax amount directly into one of my taxable accounts, since that's what I do with it because I'm still w*rking.

[robertf57]

If this is a non-qualified plan, as Big-Hitter probably correctly laid out, then you should have a good handle on how it will be paid and you should model it as a pre-tax asset taken as periodic payments per your previous election. That way you can model the tax impact on other earnings.

[Bir48die]

You are in a similar situation to me. Maybe I missed it but is this a single payout? Mine is over a ten year period.

From a modeling standpoint I treated this like tax deferred assets since I will be taxed on the income. My financial advisor didn't recognize as a total portfolio asset but used the income stream for total withdrawals.

[Closet_Gamer]

Quote:

Originally Posted by Big_Hitter I'm sure this is a NQDC plan (IRC 409A) - the OP has to elect the time (age 60/65 etc.) and form of payment (lump sum, 5 year term, etc.) before compensation is deferred; so generally, there is no decision to make regarding time or form of payment at this point https://en.wikipedia.org/wiki/Intern...e_section_409A

Thanks for all the responses.

Sorry I didn't respond for a while -- w*rk gets in the way!

Yes, this is an NQDC plan. To Big Hitter's point, you set the payouts in advance. I've got it staggered over a number of years but, as I've mentioned in past DC threads, I'm always mindful that NQDC is a non-secured asset of the business. While I think its likely near 0% chance that the company would ever get in trouble, its essentially an unsecured loan to the company so I've always tried to keep my "maturity" of those loans fairly short. Hence while it will be paid out while I'm still working. Of course, if I'm still working for the same company, I can redefer those payouts, but I'm modeling scenarios where I change jobs.

Thanks.

[Closet_Gamer]

Quote:

Originally Posted by robertf57 If this is a non-qualified plan, as Big-Hitter probably correctly laid out, then you should have a good handle on how it will be paid and you should model it as a pre-tax asset taken as periodic payments per your previous election. That way you can model the tax impact on other earnings.

Thanks. Yes, I know years and the gross value...what I don't know if how much other income will happen in those years if I change jobs. I don't take it for granted that I will continue earning what I am today (for any number of reasons including just choosing to do something different.)

[Closet_Gamer]

Quote:

Originally Posted by Bir48die You are in a similar situation to me. Maybe I missed it but is this a single payout? Mine is over a ten year period. From a modeling standpoint I treated this like tax deferred assets since I will be taxed on the income. My financial advisor didn't recognize as a total portfolio asset but used the income stream for total withdrawals.

I will be paid out over several years, not a single big lump sum.

Funny about your FA. I talked to an FA a while back when putting together a plan. FA's sort of give you that confused dog look when you bring up NQDC plans. They have playbooks for taxable and tax deferred accounts, but they seem painfully uneducated on NQDC plans...which surprises me because while not everyone has them, they are pretty common for execs and the high(er) net worth folks where FA's can really make money.