How much to contribute to deferred compensation?

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How much to contribute to deferred compensation?

Post by namekevaste » Fri May 05, 2017 7:56 pm

We are a physician couple with a combined income of approx 700k.
Emergency funds: Yes
Debt: Mortgage approx 300k at 3.6%
Tax Filing Status: Married Filing Jointly
Tax Rate: 39% Federal, 5% State
Age: mid 40s (both)
Current portfolio is in the low mid 7 figures.

Current retirement assets

4% cash
49% at Vanguard

Tax deferred/non taxable (47%)
403(b), 401(a), 457 at Fidelity
Roth IRA at Vanguard

403(b), 457(b) - inactive at Fidelity
401(k), excess benefit plan at Fidelity
Roth IRA at Vanguard

529 plans - should fund 50-80% of college expenses

The excess benefit plan has excellent fund choices with low ERs. The choice of funds also allows us to diversify in a tax efficient manner (e.g. VNQ). There is considerable flexibility in selecting distributions which are done each year for next year's contributions. For example, "starting at age 60 and over 10 years". Distribution date can be changed as long as the new date is 5 years or more from the original and the change is made at least a year in advance. The employer is a large hospital system that operates multiple facilities and has a low likelihood of bankruptcy.
Since she can shelter up to 80% of her salary, should we maximize her contributions to the excess benefit plan?

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Re: How much to contribute to deferred compensation?

Post by Hogan773 » Fri May 05, 2017 10:30 pm

I used to do this deferred comp thing but stopped awhile back when I started to feel like I had too many eggs in my employer's basket. I didn't really want to line up with all the other unsecured creditors should my employer go bankrupt. Yes, small chance I know. But would really stink to lose a million dollars of built up deferred comp just because I was trying to arb current taxes vs potential lower taxes in the future.

But would be interested in the analysis answer from others. Yes you avoid paying taxes today at highest marginal rates. Theoretically you MIGHT be able to pay lower taxes on the money in the future, depending on how much you have in there and how you are allowed to spread out the distributions when you separate and what marginal taxes look like in the future. If you do it for multiple years you still might be in the highest tax bracket with your distributions when they come back out, especially if one spouse is still working. So what happens if marginal rates are higher in the future on top of that?

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Re: How much to contribute to deferred compensation?

Post by BL » Fri May 05, 2017 11:31 pm

No advice, but Total Stock Market and Total International Stock Market are quite tax-efficient in taxable accounts if you choose to go that way.

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Re: How much to contribute to deferred compensation?

Post by dcabler » Sat May 06, 2017 5:59 am

When I was on a deferred comp plan, I put 5% of pay into it and 75% of any bonuses. Idea was to use this to fund part of the 1st 10 years of retirement. There were a few choices for how payouts happen, with the most common being a 10 year annual payout. I didn't put much more in it for fear of bankruptcy and, as another poster put it, putting a lot of eggs in my employer's basket.

But things happen. The company had a large layoff. I was let go and took another job pretty quickly at a higher pay. But the deferred comp started paying out, so now I get a check every January. I'm not in retirement so my marginal tax rate is still high, so in the end there were no benefits to having done this. Regardless, every year I happily take the check and deposit it back into my taxable investments. The deferred comp investment choices are set up to mirror the company's 401K investments - meaning the choices truly suck.

I'm sure there is a lot of value for some people, but not for me. It looks like yours has a nice choice of payoff starting at a certain age. Mine was "upon termination".

Anyway, I try to have my investments set up similarly to what I have in other accounts with a 50/50 asset allocation consisting of:
Total stock market (one of the few index funds available)
Small cap value tilt (they have DFSVX available)
Total Bond market (No TIPs fund available otherwise I would have split between total bond and TIPs for this portion)

Last edited by dcabler on Sat May 06, 2017 6:15 am, edited 2 times in total.

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Re: How much to contribute to deferred compensation?

Post by NiceUnparticularMan » Sat May 06, 2017 6:02 am

We contributed to a deferred compensation plan for a while when there was an additional employer match available on it. When that stopped, so did we. Ironically we put it in our "low-return" assets to keep it smaller in relative terms. Then 2008 hit, we rebalanced, and it gained a bunch in relative terms. Oh well.

Anyway, I can understand the case for it to the extent your alternative would be to hold high-taxable-income-producing assets in a taxable account, and munis and such were not a competitive solution. As soon as you have the alternative of using low-taxable-income-producing assets in a taxable account (e.g. stocks), I see it as not worth doing. We aren't in the first position, so that explains our decision.

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Re: How much to contribute to deferred compensation?

Post by SleepKing » Sat May 06, 2017 7:05 am

Before I give you our opinion, let me say we contributed to deferred compensation for a while. Stopped for a few reasons:

-Simply did not trust the ability of our health system to remain solvent in unknown climate over next 20-30-40 years. You say that is minimal risk in your situation.
-I was not comfortable with the payout options. As I remember, we only had a few options: take the entire distribution as a lump sum upon separation. Change the distribution date upon separation to a date within 1 year following retirement, or when we hit age 70.5. Just didn't like the inflexible non-sense of when and how i'm allowed to receive the money I earned. Sounds like you have much better options to go with.
-It's a non-quaified plan, so difficult rollover possibility and only to other, similar plans. If I make a career change or go to a different style of health system, i could have this sum stuck at old employer or need to tax massive tax hit if I want to get it out with lump.
-We would rather have our money in a taxable account, readily available to use if we change our plans or priorities.

With that said, if we remain at current health system long term, we will probably re-initiate funding deferred compensation when we anticipate retirement is within 5-10 years.

To your question
namekevaste wrote:Since she can shelter up to 80% of her salary, should we maximize her contributions to the excess benefit plan?
I don't see anything wrong with it. You are both intelligent and have thought this through. All your basics seem addressed. If you are comfortable with the risks discussed, then it would be reasonable. Another alternative could be pay off the mortgage (and any other debt) so you are completely debt free. You could probably do that within a few years. Then start the deferred comp contributions afterwards. We hate debt, even at lower rates. Psychological for us.

Good luck. You both are certainly on the right track!

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Re: How much to contribute to deferred compensation?

Post by LeeMKE » Sat May 06, 2017 9:52 am

Your deferred comp plan looks like it could be used for two things:

Early retirement - As you know, most retirement plans don't allow early w/d without penalty, and this could be substituted (with one year notice)
Disability - I'd be tempted to load this account up for a couple years and then start dropping one or both of your disability policies. As soon as your savings would cover you in the case of disability, it is time to drop those expensive policies. This could be a good way to get that self insurance.

I would not prepay your mortgage because it provides some shelter (which is NOT the advice I give almost anyone else) and you are otherwise in good shape.

So nice to see a Doc that doesn't have a collection of weirdo investments doomed to provide only tax losses. Keep going!
The mightiest Oak is just a nut who stayed the course.

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Re: How much to contribute to deferred compensation?

Post by MikeG62 » Sat May 06, 2017 1:24 pm

I participated a deferred comp plan for several years. Plan was to take payouts over extended period of time once I retired and take advantage of tax rate arbitrage. Employer got acquired and pursuant to rules of the plan, all deferred comp had to be paid out in lump sum in year company was acquired.

I bring this up as a risk you may not be considering.

I can tell you I was not happy to have a mid six figure distribution dropped in my lap all in a high income year (high in part because all company stock options were liquidated). It's just something I had not considered among the list of risks.
Real Knowledge Comes Only From Experience

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Re: How much to contribute to deferred compensation?

Post by gcinnh » Tue May 09, 2017 8:03 pm

I work for a fortune 100 company so feel safe on bankruptcy. I was 50 and contributed all my bonuses for 5 years accumulating almost a million. About to early retire and can draw 100k+ year for 10 years plus it's all invested in a guranteed income fund of 3%. So for me it's a great ER income gap with decent guranteed return so I don't have to tap my 401ks for 10 years.

Solvency is something to consider.

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Re: How much to contribute to deferred compensation?

Post by mass_biker » Tue May 09, 2017 8:33 pm

NQDC: I have been using this for the past 8+ years; I did have this at the old gig though.

Our current program allows healthy deferral - up to 50% base and 100% bonus. Enabling assumption is of course is the solvency of your employer as you are an unsecured creditor. If you are in a situation where you have PRSUs coming due every 3 years or so (which cannot be deferred), a NQDC plan is pretty useful.

There are options within - that enable "in service" distribution (college expenses, home purchase). Ideally you are funding those outside the NQDC given the restrictive nature of a NQDC plan.

Sometimes there are useful distribution options - one we have (and it works for folks in their 40s/early 50s) is the "deferred distribution" option, which allows for the first of five distributions to made on the 5th year anniversary on a separation of service (either voluntarily or on severance). That way you don't hit with with that lump sum distribution.

In terms of AA - I skew to the lower risk choices - stable value, short term investment grade etc....

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