Looking for advice on whether to participate in Deferred Compensation Plan

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calimero
Posts: 62
Joined: Mon Dec 29, 2014 8:04 pm

Looking for advice on whether to participate in Deferred Compensation Plan

Post by calimero » Sun Sep 23, 2018 8:59 pm

Hi,

My employer offers a deferred compensation plan (DCP), supplemental to 401k. I am looking for advice, thoughts on whether or not to participate in deferred compensation plan.

I have participated in the past for a couple of years and stopped. I became eligible again and trying to think through the pros and cons. The common strategy appears to be to deferred comp, assuming income is going to be less sometimes later (e.g. retirement). Thus lower taxes. Sometimes, people seem to target specific retirement years (i.e. 62-67) or plan or early retirement.

Some of the downsides I experienced:

1.) I am already capped with 401k contribution as I am labeled as “highly compensated”. The DCP contributions appeared to have an impact on the $ going into 401k as 401K salary was after DCP contribution.
2.) Managing DCP can be difficult. In particular the limited flexibility in making changes to payout (i.e. max of 3 pushbacks)
3.) Choices of funds can not be compared as it appears to be special funds from the mgmt. company

I am anticipating lower taxes with the recent changes.

Is it still a good idea? What parameters should I look at and you need to know to help answer the question?

krow36
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Location: WA

Re: Looking for advice on whether to participate in Deferred Compensation Plan

Post by krow36 » Sun Sep 23, 2018 9:08 pm

Have you looked at this on White coat Invester's blog? Be sure to read the comments also, and check out the links: https://www.whitecoatinvestor.com/shoul ... your-457b/

Wagnerjb
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Location: Houston, Texas

Re: Looking for advice on whether to participate in Deferred Compensation Plan

Post by Wagnerjb » Sun Sep 23, 2018 9:09 pm

Here are a few important issues the need to be factored into the evaluation:

How old are you now?
When do you anticipate retiring?
Do you expect to stay with your current employer all the way until retirement?
What percent of your net worth is in the DCP plan today?
How good are the investment choices in the DCP plan?

Let us know these answers and those on this board can better help you frame the pro's and con's of this decision.

Best wishes.
Andy

calimero
Posts: 62
Joined: Mon Dec 29, 2014 8:04 pm

Re: Looking for advice on whether to participate in Deferred Compensation Plan

Post by calimero » Sun Sep 23, 2018 9:18 pm

How old are you now? 48 (btw. double earners 44)
When do you anticipate retiring? Tough question at this point. - 55 - 60 max
Do you expect to stay with your current employer all the way until retirement? - not sure. But most of the DCP would not trigger. I made a mistake in one year that woudl trigger if I leave.
What percent of your net worth is in the DCP plan today? 18.5% of combined with spouse
How good are the investment choices in the DCP plan? Frankly, not sure as the products can't be researched. My view: 75% as effective as compared to open market.

Wagnerjb
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Re: Looking for advice on whether to participate in Deferred Compensation Plan

Post by Wagnerjb » Sun Sep 23, 2018 10:18 pm

In my experience, the biggest benefit from a DCP was the tax arbitrage. For example, I deferred compensation (salary and bonus) in 2013 when I would have paid 35% and 39.6% of income tax on that income. I am withdrawing those funds now in early retirement in the 12%, 22% and 24% brackets. The biggest risk is bankruptcy of your employer.

You manage (minimize) the bankruptcy risk three ways. First of all, you manage the percentage of your net worth such that a total bankruptcy would not derail your retirement. Personally, my target was 10-15%. Second, you minimize the time that your investments are exposed to this risk by waiting until later in your career to defer funds into the DCP plan. Third, you minimize the time that your investments are exposed to this risk by electing a short payout period for the post-retirement distributions.

Another risk is the one where you leave your employer before retirement, and all of the DCP funds are paid to you all at once. This is a horrible outcome, that would completely offset the tax benefits....and you may actually end up with a net negative tax benefit in that case. You would need to understand how your specific plan handles an early termination, but be sure to consider this risk too.

Given what you have said (age of 48, 18.5% of investments in DCP today, not certain to stay with employer until the end) I would not recommend any more contributions to the DCP plan.

Best wishes.
Andy

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FiveK
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Re: Looking for advice on whether to participate in Deferred Compensation Plan

Post by FiveK » Sun Sep 23, 2018 11:12 pm

calimero wrote:
Sun Sep 23, 2018 9:18 pm
How good are the investment choices in the DCP plan? Frankly, not sure as the products can't be researched.
Are they Collective Investment Trusts (CITs)? If so, they may be as good as an index fund covering the same investments, e.g., a CIT covering the S&P 500. Do you know the expense ratios?

As Wagnerjb noted, the biggest risk is employer bankruptcy, in which case you probably get nothing. Note that there is a benefit to choosing longer (i.e., at least 10 year) payout lengths, particularly if you move from a high to a low tax state: NQDP: State Income Tax Sourcing Rules.

If you have a defined benefit pension that provides a higher annual payment in return for a deferred start date, use of the deferred comp. can provide the flexibility to choose that.

In sum, deferred comp. can be very useful but is riskier than 401k, IRA, etc. So far it has worked well for us because Megacorp is still in business....

slowbutsteady
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Joined: Fri Feb 27, 2015 9:42 am

Re: Looking for advice on whether to participate in Deferred Compensation Plan

Post by slowbutsteady » Mon Sep 24, 2018 10:19 pm

Wagnerjb wrote:
Sun Sep 23, 2018 10:18 pm
In my experience, the biggest benefit from a DCP was the tax arbitrage. For example, I deferred compensation (salary and bonus) in 2013 when I would have paid 35% and 39.6% of income tax on that income. I am withdrawing those funds now in early retirement in the 12%, 22% and 24% brackets. The biggest risk is bankruptcy of your employer.

You manage (minimize) the bankruptcy risk three ways. First of all, you manage the percentage of your net worth such that a total bankruptcy would not derail your retirement. Personally, my target was 10-15%. Second, you minimize the time that your investments are exposed to this risk by waiting until later in your career to defer funds into the DCP plan. Third, you minimize the time that your investments are exposed to this risk by electing a short payout period for the post-retirement distributions.

Another risk is the one where you leave your employer before retirement, and all of the DCP funds are paid to you all at once. This is a horrible outcome, that would completely offset the tax benefits....and you may actually end up with a net negative tax benefit in that case. You would need to understand how your specific plan handles an early termination, but be sure to consider this risk too.

Given what you have said (age of 48, 18.5% of investments in DCP today, not certain to stay with employer until the end) I would not recommend any more contributions to the DCP plan.

Best wishes.
+1

Said it better than I could have.
The tortoise wins every time I read that story.

chambers136
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Re: Looking for advice on whether to participate in Deferred Compensation Plan

Post by chambers136 » Tue Sep 25, 2018 6:42 am

Check how the distribution is handled. My wife was in one that paid in one lump sum, so it defeated the goal of tax savings. Some will pay out over several years, or so I've heard. The other problem we found was she had to tell them when she wanted the distribution, and only had one chance at deferring it. This is OK if you are near retirement and intended to take it in retirement, but if you leave that job you have to either take it or guess when in the future you will want it- could be 10, 20 years later. As you may have guessed, we will not be using her deferred compensation plan in the future.

MikeG62
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Re: Looking for advice on whether to participate in Deferred Compensation Plan

Post by MikeG62 » Tue Sep 25, 2018 7:19 am

OP, another risk I wrote about a while back (company is bought out and all deferred comp is paid in a lump sum):

viewtopic.php?f=1&t=218714&p=3365565&hi ... d#p3365565
Real Knowledge Comes Only From Experience

TallBoy29er
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Re: Looking for advice on whether to participate in Deferred Compensation Plan

Post by TallBoy29er » Tue Sep 25, 2018 7:29 am

One question I have not seen brought up is the question of matching, as you framed this as a supplemental 401k. If you are a HCE, I'm guessing you may hit the federal 401k contribution limits ($18.5k) prior to end of year if you set your contributions to receive the max employer match each month. If that is the case, and your employer matches contributions a certain percent each month, then a deferred comp plan may provide you a way to get the employer match, as your deferred comp plan would then be the recipient of your, and your employer's, contributions, for the remainder of the year. Some plans work this way. If that is the case for you, it is a no brainer for me to enroll in the plan, barring extraordinary circumstances (eg a high risk employer).

Excellent advice has been given on payouts upon separation. It is a balance of getting your money out as quickly as possible due to lack of creditor protection, versus taking a tax hit. Employers may give options on how you want this paid out, ranging from annuities upon retirement age (no way I would keep my money in a non-qualified DCP that long), to payouts over a range of years, to lump sum payouts upon separation.

One other note. If you make a payout election, and then come back and change it later, there is a waiting period. First, your change does not take effect until 12 months after you make it. Second, upon separation from your employer, you then have to wait 5 years for the payout(s) to begin. Thank Enron for this nice little nugget of a law.

calimero
Posts: 62
Joined: Mon Dec 29, 2014 8:04 pm

Re: Looking for advice on whether to participate in Deferred Compensation Plan

Post by calimero » Tue Sep 25, 2018 8:11 am

TallBoy29er wrote:
Tue Sep 25, 2018 7:29 am
One question I have not seen brought up is the question of matching, as you framed this as a supplemental 401k. If you are a HCE, I'm guessing you may hit the federal 401k contribution limits ($18.5k) prior to end of year if you set your contributions to receive the max employer match each month. If that is the case, and your employer matches contributions a certain percent each month, then a deferred comp plan may provide you a way to get the employer match, as your deferred comp plan would then be the recipient of your, and your employer's, contributions, for the remainder of the year. Some plans work this way. If that is the case for you, it is a no brainer for me to enroll in the plan, barring extraordinary circumstances (eg a high risk employer).

Excellent advice has been given on payouts upon separation. It is a balance of getting your money out as quickly as possible due to lack of creditor protection, versus taking a tax hit. Employers may give options on how you want this paid out, ranging from annuities upon retirement age (no way I would keep my money in a non-qualified DCP that long), to payouts over a range of years, to lump sum payouts upon separation.

One other note. If you make a payout election, and then come back and change it later, there is a waiting period. First, your change does not take effect until 12 months after you make it. Second, upon separation from your employer, you then have to wait 5 years for the payout(s) to begin. Thank Enron for this nice little nugget of a law.
The company offers a certain match on DCP. I guess I wouldneed to optimize DCP contribution so that the remaining 401k income woudl stay high enough to allow $18.5K 401K contribution?

TallBoy29er
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Re: Looking for advice on whether to participate in Deferred Compensation Plan

Post by TallBoy29er » Tue Sep 25, 2018 8:28 am

calimero wrote:
Tue Sep 25, 2018 8:11 am
The company offers a certain match on DCP. I guess I wouldneed to optimize DCP contribution so that the remaining 401k income woudl stay high enough to allow $18.5K 401K contribution?
I don't quite understand your statement/question. Could you clarify a little more?

calimero
Posts: 62
Joined: Mon Dec 29, 2014 8:04 pm

Re: Looking for advice on whether to participate in Deferred Compensation Plan

Post by calimero » Tue Sep 25, 2018 9:57 am

TallBoy29er wrote:
Tue Sep 25, 2018 8:28 am
calimero wrote:
Tue Sep 25, 2018 8:11 am
The company offers a certain match on DCP. I guess I wouldneed to optimize DCP contribution so that the remaining 401k income woudl stay high enough to allow $18.5K 401K contribution?
I don't quite understand your statement/question. Could you clarify a little more?
A contribution to a DCP plan will reduce the reported wage. Let's say income is $200k. If I contributed 20% to DCP, income woudl be $160k.
Because I am classified as a high earner, I can only contribute 10%, period whether or not I reach $18.5k. So, in my (simplified) example I woudl end up contributing only $16k to 401k. So, I am thinking I woudl need to optimize the DCP to keep an after DCP income of $185k. Of course I woudl need to figure the exact amount due to other deductions.

calimero
Posts: 62
Joined: Mon Dec 29, 2014 8:04 pm

Re: Looking for advice on whether to participate in Deferred Compensation Plan

Post by calimero » Thu Sep 27, 2018 7:37 am

After looking at all the input I believe the following guidelines seem to make sense:
- deferring only above $185k in order not to affect 401k
- only with sable company
- up to 20% of net worth

The wildcard: gambling that ones tax rate will be indeed lower in retirement

MAR888
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Re: Looking for advice on whether to participate in Deferred Compensation Plan

Post by MAR888 » Sat Sep 29, 2018 10:59 am

I was bitten once by getting a large lump sum payout (taxed at high rate) when I left an employer before retirement. As mentioned, individuals considering DCP's need to read all of the details regarding distribution rules.

Some other factors:
1. Distributions from the DCP will be ordinary income and taxed as such. Tax on those distributions may be higher than earnings/gains from investments in a taxable accounts.
2. After retirement, DCP ordinary income reduces the amount of potential Roth conversions at lower tax rates.
3. Consider the DCP income in retirement with respect to Social Security taxation and Medicare premium impact.

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FrugalInvestor
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Re: Looking for advice on whether to participate in Deferred Compensation Plan

Post by FrugalInvestor » Sat Sep 29, 2018 11:27 am

I chose not to participate in my company's DCP not because I carefully weighed the pros and cons but because I didn't fully understand the possible ramifications other than reduced tax in the short-term. I think I innately understood that it wasn't a good idea to invest in something I didn't understand. After reading this thread I'm relieved that I didn't jump in without a full understanding as it sounds like it could have caused me a myriad of problems in both early and later retirement.

The more I read this site the more I realize how large of a role dumb luck has play in my financial life, including running across Bogleheads.
IGNORE the noise! | Our life is frittered away by detail... simplify, simplify. - Henry David Thoreau

Bacchus01
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Re: Looking for advice on whether to participate in Deferred Compensation Plan

Post by Bacchus01 » Sat Sep 29, 2018 2:32 pm

I use ours to get under the 32% tax bracket. I figure even if I take as a lump because I leave, I’m unlikely to be above the 32% bracket and at worst it’s probably a wash for taxes.

mc7
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Re: Looking for advice on whether to participate in Deferred Compensation Plan

Post by mc7 » Sat Sep 29, 2018 2:58 pm

I participate in one, but keep it as close to 10% as possible. I would not be comfortable at 18.5%. Your mileage may vary.

JW-Retired
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Re: Looking for advice on whether to participate in Deferred Compensation Plan

Post by JW-Retired » Sun Sep 30, 2018 8:28 pm

I participated with my companies Deferred Comp plan to a limited extent. I chose the 5 year payment option with the idea that I would use it as a bridge from my age 65 retirement date to delay until age 70 SS. The years of payback couldn't be changed so once my 5 year plan balance got large enough I just stopped contributions.

Still think it was a sound plan but I didn't execute it right. Didn't retire until well past my 69th birthday. :oops:
JW
Retired at Last

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