Deferred Compensation

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cinckid
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Deferred Compensation

Post by cinckid »

Would appreciate some forum advice on how to handle deferral options for deferred compensation. I plan on the deferral to start after retirement when income is lower, but is the recommendation to go with lump sump, or deferral over 5 or 10 years? Those are the only three options. Since the money is actually not moved out of the company's balance sheet, there is also some risk of losing the money, however the company is quite large, long history and very well managed. Any words of experience are appreciated.
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Dale_G
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Location: Central Florida - on the grown up side of 85

Re: Deferred Compensation

Post by Dale_G »

It partly depends on how much you expect the account to be worth on retirement. You are expecting your income to "be lower", but a lump sum could drive you into a higher tax bracket than you expect.

Look into the tax ramifications of the lump, 5 & 10 year distribution schedule. Keep in mind when you expect to start receiving SS and are forced to take RMDs. I opted for 15 years to keep the tax hit at a minimum.

Dale
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DFrank
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Location: North Idaho

Re: Deferred Compensation

Post by DFrank »

I suspect there are too many individual variables to provide a standard recommendation on distribution options. The amount you expect to accumulate, anticipated tax bracket, possible desire to use distributions to bridge to other events such as the start of a pension or social security benefits would all be considerations.

You do need to be aware of the risks involved. I've been a fairly aggressive participant in my company's deferred comp program, probably much more so than many people would be comfortable with. That said, there are a number of reasons that mitigate the risk:
  • I work for a company that has consistently been a leader in it's field
  • We build specialized hi-tech products that operate in a highly regulated environment, so there are high barriers to entry
  • There are only 1-2 other competitors in most of our market segments
  • If the company came into hard times there would still be a lot of value there, and I think we would be bought before bankruptcy happened. That would trigger a full distribution, and while that would have negative tax consequences, it's not a complete loss.
  • I'm high enough up in the company that I know the CEO and most of the executive leadership, and I consider the company to be very well managed
So I decided that the risk was manageable, and the benefit of socking away pre-tax earnings while working in CA only to withdraw them while living in a state with a more favorable tax climate in retirement was worthwhile. That said, I think I'll want to continue to pay close attention to the health of the company until my distributions are complete.

I might also mention that our plan offers some great fund options including VIIIX, VFWPX, and VBMPX, so that was a factor as well.

While everyone's circumstances are different, here is how I thought about the distribution question. My plan is to take distributions over a 10 year period following my retirement, which is planned when I am 61. My wife will be 52 at that time, and she will continue working for 4-5 years. I have a small pension that will start when I am 62, and plan to take social security when I am 70. During the time my wife is working we will still be savers - our expenses will be less than the sum of her salary plus my deferred comp distributions. Once she stops working we'll be able to cover about 75% of our expenses with deferred comp plus my pension. So in our case we are using the deferred comp distributions to help bridge us to my social security benefit start at age 70. Social security will replace about 40% of the deferred comp payout, and we'll begin more significant withdrawals from our savings at that time.
Last edited by DFrank on Thu Feb 12, 2015 11:59 am, edited 2 times in total.
Dave
Bacchus01
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Re: Deferred Compensation

Post by Bacchus01 »

At my company, if you leave or retire before early retirement date, which is 55 and 10 yrs of service, you must take it as a lump sum.

I struggle with participation as I know I would save a lot in taxes now, but I also do not anticipate working until 55. That would mean I'd take it all as a lot sum and likely would be in the same, or higher, tax bracket than I am today.

Is there any reason to contribute in this situation that I'm missing? There is no company match.
DFrank
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Re: Deferred Compensation

Post by DFrank »

Bacchus01 wrote:At my company, if you leave or retire before early retirement date, which is 55 and 10 yrs of service, you must take it as a lump sum.

I struggle with participation as I know I would save a lot in taxes now, but I also do not anticipate working until 55. That would mean I'd take it all as a lot sum and likely would be in the same, or higher, tax bracket than I am today.

Is there any reason to contribute in this situation that I'm missing? There is no company match.
I would say probably not. Depending on the timing of the distribution you may not even be able to take advantage of being in a low or no income tax state if that was part of your retirement plan.

Distributions from our plan happen in January of the year following your retirement, so depending on when you retire that gives you time to move to another state if that is your intention. If you leave the company for any reason after age 55 they treat that as a retirement for the purposes of the deferred comp plan.
Dave
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N1CKV
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Re: Deferred Compensation

Post by N1CKV »

Is this a qualified plan that can be rolled in to an IRA? (like a 457b?)

If so what age would you retire? If it's after 59.5 then take a lump sum rolled over to a tIRA and you can manage the tax as you go. If you will be under 59.5, will you need the money before 59.5? If so then it's the same answer.
Wagnerjb
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Re: Deferred Compensation

Post by Wagnerjb »

I chose 5 years in my company's deferred comp plan. As others have mentioned, taking a Lump Sum will drive you into a very high rate in that particular year - thus offsetting the tax benefits that you expected to receive. I chose the shorter time period (we could also go out 10 years or more) to limit the bankruptcy exposure for my company. I work for a very large energy company, but I know people who worked at Enron and BP so I take the risk - however small - very seriously. I don't shy away from this risk (since it is well compensated with tax benefits) but I acknowledge and understand it....and I manage it with moves such as the shorter distribution period.

The 5 year payout period will commence with my retirement at an age such that the payout years are between ages 55 and 70.5, so I can keep the taxes down. The payout in any of those 5 years is less than my living expenses, so I would likely be withdrawing funds from my pretax accounts anyway.

Best wishes.
Andy
JW-Retired
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Re: Deferred Compensation

Post by JW-Retired »

cinckid wrote: Would appreciate some forum advice on how to handle deferral options for deferred compensation. I plan on the deferral to start after retirement when income is lower, but is the recommendation to go with lump sump, or deferral over 5 or 10 years? Those are the only three options. Since the money is actually not moved out of the company's balance sheet, there is also some risk of losing the money, however the company is quite large, long history and very well managed. Any words of experience are appreciated.
I took a 5 year annuity option so as to use it as a bridge from age 65 to age 70 SS and RMDs. Once this option was selected it was impractical to change it. I think it was a good plan but, as it worked out, I didn't retire until age 69 so it was a poor tax move.

Since you are planning on retiring quite early I wouldn't hesitate to defer over 5 or 10 years.
JW
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DFrank
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Location: North Idaho

Re: Deferred Compensation

Post by DFrank »

N1CKV wrote:Is this a qualified plan that can be rolled in to an IRA? (like a 457b?)

If so what age would you retire? If it's after 59.5 then take a lump sum rolled over to a tIRA and you can manage the tax as you go. If you will be under 59.5, will you need the money before 59.5? If so then it's the same answer.
No, these are unqualified plans, and you can not roll these over into an IRA. They are mainly of interest to people who have maximized their savings in qualified plans and are looking for some more tax deferred savings opportunities.

I can't cite all the legal requirements chapter and verse, but some of the key requirements are that your money has to be "at risk," you must choose a distribution plan for your deferrals up front, and there are stringent limitations on changing your distribution plan at a later date. For example, any change to your distribution plan has to delay your deferral, and at least in our plan by at least 5 years. "At risk" means that you are becoming an unsecured creditor of the company, so that's why it's vital that you assess the risk given your company and the amount you plan to defer.
Dave
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Steelersfan
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Re: Deferred Compensation

Post by Steelersfan »

Taking it all at one time probably isn't the best move for the tax reasons others have stated. Whether you receive it over two or five or ten years depends on many factors, one of which is how stable the company is since these monies are potentially exposed in the event of a company bankruptcy.

I choose a very conservative three years, which didn't start until two years after my retirement since I had to unwind some other financial arrangement. So in reality I was exposed for five years.

In hindsight longer would have been better. But hindsight doesn't apply when you have to make a decision now.
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