Deferred Compensation Savings Plan

[Willers]

I've been offered the opportunity to participate in a deferred comp plan. In a nutshell, the rules of the plan allow up to 50% of salary to be deferred and invested in the plan. Distribution happens upon retirement (defined as 60), disability, job separation, or death.

In reviewing the documents and researching these online I understand that this is basically a "promise" of payment and isn't vested in any way so it does depend on the health of the company, which I would consider to be about average (long-time company, currently some profitability issues).

The tax benefits are attractive since our income with drop significantly in retirement, but I know there is no free lunch. Has anyone out there participated in one of these? If so, did you experience any negative outcomes, surprises, etc?

Thanks!

 

[trapperjohn]

I participate in a deferred comp plan where I w**k. The pre-tax money goes into a fund and I can control how it is invested.

When you retire or quit, you can roll everything into a tIRA. Very secure. Not tied to company performance.

Sent from my HTC_Amaze_4G using Early Retirement Forum mobile app

 

[ImThinkin2019]

My DW particpates in one as well. Even though the plan docs say it's a "promise of payment" her employer actually deposits the money into an account where she can make the investment decisions. So it seems that the payment risk is very small.

We're using this to reduce our tax burden short term while socking away $$ in the sprint to the finish. We think it's a wonderful opportunity and we're very grateful to the employer.

 

[Willers]

Thanks for the info on your experiences. My HR rep did say that if the company went under that I'd be considered a creditor and the dollars could be at risk. I consider that a low probability in the time I have remaining.

Seems like a great deal...

 

[steelyman]

I participate in a deferred comp plan (457). I could have taken the funds out or rolled over when I left work but chose to leave them in as it has a few options I like that aren't available to me elsewhere: Columbia Acorn Z, Vanguard Total Bond Institutional Plus, and Invesco Stable Return.

(not recommendations - just my choice!)

 

[robnplunder]

It can lower your company's 401k match. YMMV based on the matching percentage.

 

[Willers]

It can lower your company's 401k match. YMMV based on the matching percentage.

Thanks. I didn't think about that.

 

[Willers]

I participate in a deferred comp plan (457). I could have taken the funds out or rolled over when I left work but chose to leave them in as it has a few options I like that aren't available to me elsewhere: Columbia Acorn Z, Vanguard Total Bond Institutional Plus, and Invesco Stable Return.

(not recommendations - just my choice!)

We have a similar situation in my wife's 401k. We'll likely not roll that into an IRA because it gives me access to a two closed funds I really like.

It will be interesting to see what investment options are offered. I haven't seen the list yet.

 

[pb4uski]

Sounds like an unqualified deferred comp plan where the deferred comp is a general obligation of the company. I'm not keen on such plans only due to the credit risk, but if the tax savings are significant it might be worth considering.

 

[jwkde]

I participated in one for several years before ER. We did not have the option of rolling it into any type of other deferred plan (401k, IRA)

If you separate before 'retirement' it was a lump sum payout which could drive you into a higher tax bracket than you were in before the deferral.

 

[pb4uski]

That's what I was thinking also. It would make no sense that they would allow you to roll it into an IRA since it would effectively be violating IRA contribution limits. Same with 401k.

 

[robnplunder]

I participated in one for several years before ER. We did not have the option of rolling it into any type of other deferred plan (401k, IRA)

If you separate before 'retirement' it was a lump sum payout which could drive you into a higher tax bracket than you were in before the deferral.

Companies have different rules on payout. My megacorp will pay it out a fixed amount quarterly. The only exception is that it will be a lump sum payout if the total amount is less than $10k. Op's mileage may vary on this.

 

[Willers]

As mentioned, this can't be rolled to a 401k/IRA. It will be paid out and treated as compensation when I leave.

Under $100K is paid out in a lump sum. If over $100K it's paid in installments. The savings is compelling given our current and future tax situations but, as pb4uski pointed out, it is a general obligation and 100% at risk. That risk is probably my biggest concern at this point since 2 VP's just got walked out (after I started this thread) because of the earnings outlook. Oh well, so much for a stable family business.

I'll likely only be around for 12-18 months so I'm trying to judge the risk/reward on this one. I guess it may come down to a gut feel on the business health over the next two years. I've always said that every financial question could be answered with a spreadsheet. I might have found the exception.

Thanks everybody for your input.

 

[pb4uski]

If you're only talking a couple years then the credit risk is probably not very high assuming that the company's short term debt (if it has some) has reasonable credit ratings.

 

[Closet_Gamer]

I participate in a deferred comp plan and have thought this through A LOT. Our company pays a high fixed interest rate on the deferred money.

It's the best thing ever for wealth creation, but you have to watch your asset allocation as this is definitely at-risk money. You are an unsecured debt holder of the company. Should catastrophe strike and your company go bankrupt you are in-line behind every bond holder and should be paid out alongside unpaid vendors.

In that regard, deferred comp is a private, illiquid junk bond issued by your company.

If you come home and say to your spouse "I'm putting 50% of my income into a deferred comp plan that let's me duck the highest tax bracket," you sound like a genius.

If you come home and say "I'm putting 50% of my income into a totally illiquid, unsecured bond of a single company," you sound like you've gone off your meds.

Like a bond, you have to look at the time to maturity, credit rating of the issuer and risk. But mostly keep and eye on asset allocation. It's easy to look up and suddenly have 20% of your assets in this debt instrument because all of the near term incentives are aligned to encourage maximum deferral.

When I do my AA, I score this like a bond and have adjusted the rest of my portfolio to account for this.

Feel free to ping me with any questions publicly or via private message.

Deferred comp rocks. Good luck.

 

[Texas Proud]

It can lower your company's 401k match. YMMV based on the matching percentage.

Why can it lower match AFAIK, the two are completely separate... one does not affect the other....

 

[Willers]

Why can it lower match AFAIK, the two are completely separate... one does not affect the other....

Our company matched 3% of our base/bonus so if I defer 50% my assumption is that the comp would go down and correspondingly, the match. The % wouldn't change, but the $'s would. One more factor to consider.

 

[Willers]

Thanks krotoole. I just had that conversation with my wife and we discussed both the genius and loon scenarios. I agree that is a lot like a short-term junk bond... AA will be OK, but looking at this as part of the high-yield/junk slice is a good way to look at risk assessment.

I was just thinking that it would be funny to call the owner and ask "so, any plans to fold the company in the next two years"

 

[Milton]

My HR rep did say that if the company went under that I'd be considered a creditor and the dollars could be at risk…. Seems like a great deal.

I wouldn't even consider making an unsecured loan to a family business (especially one currently facing "some profitability issues"), merely to save a bit on taxes.

Keep things simple and transparent, and don't be greedy. Take your regular pay, save as much as you can and invest it in a diversified portfolio of your choice and under your full control.

 

[Closet_Gamer]

I was just thinking that it would be funny to call the owner and ask "so, any plans to fold the company in the next two years"

That would be funny...unless they stutter when answering!

Would be good to sniff out, if possible, how much money other senior execs have in the plan. If the head honchos are well exposed, at least they have the same incentives you do. At our company, the execs have huge exposure, the company is very well run financially, and has a stellar credit rating so I feel pretty good about my investment. But its still a big part of my AA so I manage the time-to-maturity like a hawk. (We can defer for a set period of years.)

 

[H2ODude]

I'd guess half our assets came from local government 457 plans starting in early 80's. I remember reading the fine print and was a little concerned that you were at risk of the city going bankrupt, but it didn't seem likely for that city. In those early days IIRC it was insurance companies, not Vanguards or FIDOs that were doing these, and the performance sucked (for my available funds). Still, the tax dodge was worth it. As soon as I could I rolled them into IRA; IIRC they didn't allow us to do that in the plan I was in in 80's until about 5 years after I left. As soon as I could I got it over into FIDO IRA.

What was great was last job had the 457 AND a 401k, so over 55 you could sack away over 40k a year. Of course now I have more than half of a considerable portfolio waiting to be whacked by the tax man when the minimums kick in. We do't really have much incentive to Roth it because we'er already in upper brackets with pension and dividends. Oh well, having to pay taxes isn't necessarily a bad think if it's because you have income!

 

[Texas Proud]

Our company matched 3% of our base/bonus so if I defer 50% my assumption is that the comp would go down and correspondingly, the match. The % wouldn't change, but the $'s would. One more factor to consider.

I was assuming that the OP was already maxed out on their 401(k).... if not, then you do not need to put money into an unqualified plan.... just put it in the qualified one!!!

 

[Willers]

I was assuming that the OP was already maxed out on their 401(k).... if not, then you do not need to put money into an unqualified plan.... just put it in the qualified one!!!

Yup, I am maxing out the 401k, but the match is 3% of overall pay, which would be reduced by deferring. I'll still have the max on my end, but a little less from their side. They wouldn't match on the post-employment payout.

 

[Texas Proud]

Yup, I am maxing out the 401k, but the match is 3% of overall pay, which would be reduced by deferring. I'll still have the max on my end, but a little less from their side. They wouldn't match on the post-employment payout.

Ahhhhh.... this make no sense to me....


If you are maxing out your 401(k), then you are also maxing out your match... IOW, they cannot put more 'match' in than what you can put in...


Now, if you are saying that they put in 3% of total compensation, including bonus..... well, that is not a match, but a contribution.... (and I would not think they would be putting that in your 401(k)).....


Also, check to see if this contribution if affected by deferring bonus... I never made enough to qualify when I worked at mega, but I do think that the cash balance account was not affected by the deferral...

 

[Willers]

Ahhhhh.... this make no sense to me....


If you are maxing out your 401(k), then you are also maxing out your match... IOW, they cannot put more 'match' in than what you can put in...


Now, if you are saying that they put in 3% of total compensation, including bonus..... well, that is not a match, but a contribution.... (and I would not think they would be putting that in your 401(k)).....


Also, check to see if this contribution if affected by deferring bonus... I never made enough to qualify when I worked at mega, but I do think that the cash balance account was not affected by the deferral...

I didn't list the terms of the match clearly:

The 401k match is 50% of the employee contribution up to the first 6% of that contribution. That is why I referred to it as a 3% match (yes, poor wording...). You are right, it is not a 3% contribution, it is a 50% match of the 1st 6%.

Example:
Salary totals $50K. They contribute (what I called a match) up to 3% (50% of 6%). With a biweekly gross of $1923, as long as I contribute >=$115 (6% of $50K/26 pay periods), they will add ~$58 ($1500 annually). A larger contribution doesn't get me more.

If I defer 1/2 ($25K deferred) then my biweekly gross would go to $962. Again, they match 50% of the first 6% I put in. Their match is now ~$29. I could still contribute more of each check to the max. The biweekly match would still be ~$29 ($750 annually). Same story on contributing more.

Maxing the contribution does max the match, but the difference in the reported salary changes the total match.

Feel free to correct my math if I am missing something.