Question - Deferred Compensation Plan

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DKD
Posts: 29
Joined: Mon Feb 01, 2016 9:29 pm

Question - Deferred Compensation Plan

Post by DKD » Wed Nov 22, 2017 2:49 pm

I have an opportunity to leverage my company's NonQualified Voluntary Deferred Compensation Plan and I'd like some advice. I can defer up to 50% of my salary. So, let's say I'm making $300k and I deferred 50%, leaving $150k. I would invest the deferred income in Vanguard and get it back when I retire, over a 5 year period, in 5 equal payments. This wouldn't leave me enough new take home pay, at my reduced salary, to pay the bills, with two kids in college. So, I'd dip into my after tax money (already paid taxes on it) in my Vanguard portfolio to offset the difference. My thought is I would come out significantly ahead, even though I'm spending some of my after tax savings. I'd be deferring the state and federal taxes on the $150k and paying a lot less taxes on it later when I take it out at $30k/year, as part of my $145k/year total retirement income, which would all be taxable. I'd also be saving federal and state taxes on my new current salary of $150k. I think I would net out significantly ahead with this approach. Am I thinking this through the right way? Thanks

retiredjg
Posts: 30852
Joined: Thu Jan 10, 2008 12:56 pm

Re: Question - Deferred Compensation Plan

Post by retiredjg » Wed Nov 22, 2017 3:03 pm

This would not interest me. You may have already seen this information, but maybe others have not. In particular, what if you leave the company prior to retirement? You might be forced to take distributions at a time when your tax rate is still high. Not to mention....I would not have my retirement money subject to being taken from me by the creditors of my employer.

https://www.fidelity.com/viewpoints/retirement/nqdc

In my mind, putting a little money there from your actual salary could be OK, but I would not borrow from Peter to pay Paul to set up such an arrangement. Too many risks for me.

Wagnerjb
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Joined: Mon Feb 19, 2007 8:44 pm
Location: Houston, Texas

Re: Question - Deferred Compensation Plan

Post by Wagnerjb » Thu Nov 23, 2017 3:00 pm

Your thought process regarding tax issues seems sound. However, you haven't addressed a few other very important issues:

1) How close to retirement are you? I am a fan of these Deferred Compensation plans, but only when reasonably close to retirement. Otherwise, the risks of leaving your employer before retirement (with an ugly tax bomb) are too high.

2) What percentage of your net worth will be in the NQDC plan? I set a personal target of 10% to limit the risk of an employer default, such that a default wouldn't derail my retirement.

3) How much of your after-tax money will you burn through while deferring into the NQDC plan? I found that I retired with too little in after-tax funds such that I don't have as much flexibility to manage my taxes in retirement as I would like. (Yes, I saved tax money doing so....but I still wish I had more after-tax flexibility).

The answers to those questions will determine if contributing to the NQDC plan is right for you at this time. It may make more sense later in your career, or at lower levels of contribution.

Best wishes.
Andy

Soon2BXProgrammer
Posts: 316
Joined: Mon Nov 24, 2014 11:30 pm

Re: Question - Deferred Compensation Plan

Post by Soon2BXProgrammer » Fri Nov 24, 2017 9:58 am

the other thing that having a NQDC plan does is it almost eliminates low tax space in the years it pays.

If you didn't do the NQDC plan, you could spend taxable, and convert pretax to roth in those 5 years...

Just something to think about.

Wagnerjb
Posts: 7030
Joined: Mon Feb 19, 2007 8:44 pm
Location: Houston, Texas

Re: Question - Deferred Compensation Plan

Post by Wagnerjb » Fri Nov 24, 2017 11:32 am

Soon2BXProgrammer wrote:
Fri Nov 24, 2017 9:58 am
the other thing that having a NQDC plan does is it almost eliminates low tax space in the years it pays.

If you didn't do the NQDC plan, you could spend taxable, and convert pretax to roth in those 5 years...

Just something to think about.
I am not sure I agree that converting to Roth is a superior strategy from a strictly tax standpoint. Here is how I see it:

You can use the NQDC plan and defer income today that would be taxed at 35%, and take the income in early retirement at 0%, 10%, 15% and 25%. This is exactly the same benefit you would derive from converting to a Roth in retirement...assuming you would otherwise be withdrawing from the TIRA at 35%. This benefit is what I refer to as tax arbitrage....paying income tax at a lower rate than you would otherwise pay.

However, by using the NQDC plan you also gain tax deferral. Instead of paying tax today, you get to pay the tax on the withdrawals much later in retirement. This is a very real benefit and separate from the tax arbitrage benefit. This benefit includes the time value of money.

I am a big fan of converting to a Roth in early retirement, but I am not sure it necessarily trumps the use of the NQDC plan.

Best wishes.
Andy

Soon2BXProgrammer
Posts: 316
Joined: Mon Nov 24, 2014 11:30 pm

Re: Question - Deferred Compensation Plan

Post by Soon2BXProgrammer » Sat Nov 25, 2017 8:53 am

Wagnerjb wrote:
Fri Nov 24, 2017 11:32 am
Soon2BXProgrammer wrote:
Fri Nov 24, 2017 9:58 am
the other thing that having a NQDC plan does is it almost eliminates low tax space in the years it pays.

If you didn't do the NQDC plan, you could spend taxable, and convert pretax to roth in those 5 years...

Just something to think about.
I am not sure I agree that converting to Roth is a superior strategy from a strictly tax standpoint. Here is how I see it:

You can use the NQDC plan and defer income today that would be taxed at 35%, and take the income in early retirement at 0%, 10%, 15% and 25%. This is exactly the same benefit you would derive from converting to a Roth in retirement...assuming you would otherwise be withdrawing from the TIRA at 35%. This benefit is what I refer to as tax arbitrage....paying income tax at a lower rate than you would otherwise pay.

However, by using the NQDC plan you also gain tax deferral. Instead of paying tax today, you get to pay the tax on the withdrawals much later in retirement. This is a very real benefit and separate from the tax arbitrage benefit. This benefit includes the time value of money.

I am a big fan of converting to a Roth in early retirement, but I am not sure it necessarily trumps the use of the NQDC plan.

Best wishes.
I agree, sorry I wasn't clear. I actually have a NQDC plan that i participate in, (payable over 15 years post separation) (1/15, 1/14, 1/13, etc).
My point is that a person should really model and look at all of their options.

I might argue participate up to the amount you can WITHOUT having to sell taxable investments. Yes, this might be a sub optimal situation, but if the taxable investments are invested well, having them around for a little diversification isn't a bad thing. (personally i'm not selling my taxable dollars)

Or i might participate to the top of whatever bracket i think i'd be in in retirement. i.e today 33% and so either get yourself to the top of the 28% or 25% bracket as an example. i would think twice about doing "extra" in the 25% bracket. (if that is the future range).. Also, i'd seriously monitor the projected balance as its only a 5 year payment schedule. to make sure i don't overload my NQDC plan to blow through the top of the 25% bracket during distribution. (this is roughly what i'm doing, also, to make it more complex, if you wanted to you could do extra NQDC and buy yourself space in the 25% bracket today, to turn around and do some roth conversions in... if your interested in that sort of thing, but i wouldn't create space in the 25% bracket and then leave it unused.)

euroswiss
Posts: 108
Joined: Sun Oct 25, 2015 4:40 pm

Re: Question - Deferred Compensation Plan

Post by euroswiss » Sat Nov 25, 2017 10:38 am

To the OP: yes, your strategy makes sense, assuming you have considered the caveats pointed out already (I.e. you are fairly close to retirement, you are fairly certain that you’ll stick with your current employer for the duration, and you are pretty confident in your employer’s financial stability)

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