Question on deferred comp options at work

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Minnesota97
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Joined: Tue Feb 19, 2013 2:01 pm

Question on deferred comp options at work

Post by Minnesota97 »

I started a MegaCorp a few months back and I received an email from benefits that at my level, I have the option to defer quite a bit of my comp in a deferred compensation plan, and this does not impact my ability to contribute to a 401K.

- I have excess room in our budget of about $1800 per month, after we meet all of our savings goals (401K, IRA, 529s, etc.) and I have been putting that extra in an after tax account. So I guess I could direct about $24,000 into a deferred account which I can invest in an S&P 500 Index.

- I also have the option of deferring 90% of my cash bonus into the same deferred account. My cash bonus has a target of $40,000, so I could defer up to $36,000. I don't need the cash and would have just put it in our taxable account. After 401K and taxes, the net amount of the $40,000 bonus would be about $22,000 or so. So aren't I better off deferring the cash bonus and deferring some of the comp above?

This is all new to me, but it seems like a no-brainer to defer as much as I can if we don't need the money, right?

- Finally, as part of a stock bonus I have the option of taking 25% as stock options and 75% as RSU's; or I can take 100% as RSUs. The stock option choice is 5 options for every RSU. For those that have a choice, which option would you go with?

The highest tax bracket in our state is 9.85%, which we blend into. Our federal income bracket blends into the 33% rate.

Thank you for any insight.
jebmke
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Re: Question on deferred comp options at work

Post by jebmke »

One thing to keep in mind is that normally these deferred comp programs are non qualified and often unfunded. If the company goes away you are just another creditor. Because of this, and the fact that I had a significant NQ option program at the same time, I chose not to defer any cash compensation when I was eligible.
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Wagnerjb
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Re: Question on deferred comp options at work

Post by Wagnerjb »

The tax deferral and the tax arbitrage offered by these plans is quite powerful. However, due to the risk of forfeiture (in bankruptcy), my advice is to generally wait until closer to retirement to fund these plans. In addition, you can reduce your risk by electing a short payout period once you retire (again, reducing your exposure to bankruptcy). Finally, as another risk reducing measure I suggest that you keep the amount invested in the Deferred Comp plan to a manageable amount - such that you could still retire comfortably if you lost it all. For me this target was 10% of my net worth.

Best wishes.
Andy
Topic Author
Minnesota97
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Re: Question on deferred comp options at work

Post by Minnesota97 »

Wagnerjb wrote:The tax deferral and the tax arbitrage offered by these plans is quite powerful. However, due to the risk of forfeiture (in bankruptcy), my advice is to generally wait until closer to retirement to fund these plans. In addition, you can reduce your risk by electing a short payout period once you retire (again, reducing your exposure to bankruptcy). Finally, as another risk reducing measure I suggest that you keep the amount invested in the Deferred Comp plan to a manageable amount - such that you could still retire comfortably if you lost it all. For me this target was 10% of my net worth.

Best wishes.
Thank you both for the feedback.

I am not worried about MegaCorp going bankrupt (I know I know...Enron, et al). The greater risk is my company being bought out by Super Global MegaCorp at some point. From the first two posts, is the potential risk of bankruptcy the only downside in your eyes?

Re: 10% of net worth - I could fund bonus for a couple of years and some of the salary (say, half of what I put in the OP) and still be a bit lower than 10% of the NW. I like that idea though.

Thanks.
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Steelersfan
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Re: Question on deferred comp options at work

Post by Steelersfan »

For the plan I was in, if I terminated employment or was terminated before retirement, the entire balance was paid out to me in a lump sum right away. If I was otherwise employed, that would make it taxable at a very high rate, maybe higher than when I was employed and putting money into the plan. The beauty of these plans is that they usually pay out after employment ends, so your marginal tax rate is less than when you were working.

That's another reason to only start putting money in them until you're closer to retirement. You have a much better idea of you're going to work there until you retire.

Check your plan documents and see how they handle disbursement if you leave the company before retirement.
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Don Christy
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Re: Question on deferred comp options at work

Post by Don Christy »

Steelersfan wrote:For the plan I was in, if I terminated employment or was terminated before retirement, the entire balance was paid out to me in a lump sum right away. If I was otherwise employed, that would make it taxable at a very high rate, maybe higher than when I was employed and putting money into the plan. The beauty of these plans is that they usually pay out after employment ends, so your marginal tax rate is less than when you were working.

That's another reason to only start putting money in them until you're closer to retirement. You have a much better idea of you're going to work there until you retire.

Check your plan documents and see how they handle disbursement if you leave the company before retirement.
That's a good point. My plan had several payment options, including a series of annual payments after termination.
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Wagnerjb
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Re: Question on deferred comp options at work

Post by Wagnerjb »

As mentioned by others, the risk of the plan giving you a complete distribution - while you are working elsewhere - is also one to watch. Waiting until later in one's career is a great way to manage that risk.

In my case, I made my first Deferred Comp contribution at age 48 and made several more before I retired at age 57. My payout is over five years, the minimum allowed.

In my case, MegaCorp spun off the division in which I worked when I was 55 years old. However, the Deferred Comp plan (along with the pension, 401k, etc) was retained intact by the newly spun off company. As mentioned by others, be sure to understand the risk of an immediate payout.

Don't lose sight that an immediate payout isn't a fatal event. It just means you probably pay a bit more in tax on the funds in the plan. An immediate payout is very different from a bankruptcy, where you may lose it all.

Best wishes.
Andy
mass_biker
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Re: Question on deferred comp options at work

Post by mass_biker »

I use NQDP...each plan is a little different though so read them carefully and spend time with HR understanding how your specific plan works.

My plan has a feature (something I had to ferret out from HR) that participants had a one time ability to "re-defer" their distribution. As such, upon a qualifying event (i.e. separation from the company), I can redefer distribution for another five years, at which point what is left is distributed to me over five years.

Once you get comfortable with the risks inherent in a plan (i.e you are an unsecured creditor) you have to make the decision as to how much you want to put away. For me, it comes down to deferring bonus payments (usually 100%) and some % of base.

If you are a highly compensated individual and max out everything else: 401k, TIRA, 529 etc., judicious use of a NQDP is a great way to enhance deferral.
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