Distributions from non-qualified deferred comp plan

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Topic Author
hoeboe
Posts: 62
Joined: Tue Jul 06, 2010 10:43 am

Distributions from non-qualified deferred comp plan

Post by hoeboe »

Several questions for those experienced with non-qualified deferred compensation plans.

For what it's worth, I know many folks are uncomfortable with these plans since they are unfunded and at risk if your employer goes bankrupt. They are also very inflexible in terms of when you take distributions. I am thankful I took advantage of it due to massive tax savings, but looking forwards to getting back out!

Background: I have been contributing to my employer's top-hot non-qualified deferred compensation plan for many years. I will be retiring early in the next year or so. Yearly lump sum distributions start Jan 2023 and will fund the majority of about 8-10 years worth of expenses. Remainder will be covered by my taxable investment portfolio.

1) When distributions occur, what taxes will be withheld? Obviously federal income taxes (no state for me). What about SSDI? Medicare?

2) What is the expected federal withholding rate? Each lump sum will be about 80k-120k. Since each comes in a single "paycheck" are withholdings at the 22% supplemental rate? I expect to be in a much lower tax bracket so I expect to owe little taxes on the distribution. I know any over withholding will be resolved after filing tax returns, but I don't like the idea of waiting a year for >$10k refunds.

3) Does the distribution count as earned income? Can it be used to fund non-taxable IRAs? Roth IRAs? HSA (I will be in a retiree HDHP supplemented by my employer)?

4) Any other "gotchas" with distributions?

Thanks!
jebmke
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Re: Distributions from non-qualified deferred comp plan

Post by jebmke »

hoeboe wrote: Tue Oct 13, 2020 7:32 am 3) Does the distribution count as earned income? Can it be used to fund non-taxable IRAs?
No
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MikeG62
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Re: Distributions from non-qualified deferred comp plan

Post by MikeG62 »

hoeboe wrote: Tue Oct 13, 2020 7:32 am
1) When distributions occur, what taxes will be withheld? Obviously federal income taxes (no state for me). What about SSDI? Medicare?
No SSDI or Medicare. Those were already withheld on the gross income from which contributions to the plan were made.
hoeboe wrote: Tue Oct 13, 2020 7:32 am 2) What is the expected federal withholding rate? Each lump sum will be about 80k-120k. Since each comes in a single "paycheck" are withholdings at the 22% supplemental rate? I expect to be in a much lower tax bracket so I expect to owe little taxes on the distribution. I know any over withholding will be resolved after filing tax returns, but I don't like the idea of waiting a year for >$10k refunds.
Pretty sure they will withhold at the supplemental rate. I don't think you can influence that in your case.

Consider yourself lucky. I contributed to my former employers non-qualified deferred comp plan for many years too. Was expecting to receive payouts over many years post retirement. Unfortunately, employer was acquired and plan required full payout in that year. Lost the large tax rate arbitrage I was planning for. It was a push in terms of tax rate as contributions were made in years where I was in the highest tax bracket and income dumped in all in one year when I was also in the same highest tax bracket. Did pick up some employer match on my contributions so it was not a total waste.
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leftcoaster
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Re: Distributions from non-qualified deferred comp plan

Post by leftcoaster »

Interesting that folks would pay into these over many years. If you are as certain as one can be that your current employer will be your last, then sure. But if you separate before then...maybe not the best time to take the income.
retiredjg
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Re: Distributions from non-qualified deferred comp plan

Post by retiredjg »

hoeboe wrote: Tue Oct 13, 2020 7:32 am 1) When distributions occur, what taxes will be withheld? Obviously federal income taxes (no state for me). What about SSDI? Medicare?
I would have thought just federal taxes, but this investopedia article says that FICA will be withheld as well.

https://www.investopedia.com/articles/p ... rement.asp



3) Does the distribution count as earned income? Can it be used to fund non-taxable IRAs? Roth IRAs? HSA (I will be in a retiree HDHP supplemented by my employer)?
I would not think so.
NotWhoYouThink
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Re: Distributions from non-qualified deferred comp plan

Post by NotWhoYouThink »

For a high-earner 457 at a private company, you paid FICA on the income as it went in, there should be no further deduction as it comes out.
Soon2BXProgrammer
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Re: Distributions from non-qualified deferred comp plan

Post by Soon2BXProgrammer »

hoeboe wrote: Tue Oct 13, 2020 7:32 am 1) When distributions occur, what taxes will be withheld? Obviously federal income taxes (no state for me). What about SSDI? Medicare?

2) What is the expected federal withholding rate? Each lump sum will be about 80k-120k. Since each comes in a single "paycheck" are withholdings at the 22% supplemental rate? I expect to be in a much lower tax bracket so I expect to owe little taxes on the distribution. I know any over withholding will be resolved after filing tax returns, but I don't like the idea of waiting a year for >$10k refunds.

3) Does the distribution count as earned income? Can it be used to fund non-taxable IRAs? Roth IRAs? HSA (I will be in a retiree HDHP supplemented by my employer)?

4) Any other "gotchas" with distributions?

Thanks!
1) In most plans, as long as your SS and Medicare was already withheld (normally it is), then no SS and no Medicare.

2) It will be withheld at the 22% rate. (they don't know if you are going to work another job)

3) No it doesn't count as earned income for IRA/Roth IRA. From IRS Pub 590-A (your NQDC distribution should be in both box 1 and box 11 of a W2)
Wages, salaries, etc.Wages, salaries, tips, professional fees, bonuses, and other amounts you receive for provid-ing personal services are compensation. The IRS treats as compensation any amount properly shown in box 1 (Wages, tips, other compensation) of Form W-2, Wage and Tax Statement, provided that amount is reduced by any amount properly shown in box 11 (Nonqualified plans). Scholarship and fellowship payments are compen-sation for IRA purposes only if shown in box 1 of Form W-2.
the HSA is a a different story, there is no earned income requirement for HSA contributions, therefore you can save in an HSA.
Topic Author
hoeboe
Posts: 62
Joined: Tue Jul 06, 2010 10:43 am

Re: Distributions from non-qualified deferred comp plan

Post by hoeboe »

leftcoaster wrote: Tue Oct 13, 2020 8:07 am Interesting that folks would pay into these over many years. If you are as certain as one can be that your current employer will be your last, then sure. But if you separate before then...maybe not the best time to take the income.
Thanks for the feedback. There are differences between plans. Mine will not distribute if I quit/retire/RIFed. In fact, distributions have the strictest rules.

In the unlikely event the company is purchased, it may be a different situation.

In my case, I've been able to set aside a considerable sum in a tax advantaged space. Interesting to hear that more people would not take advantage of this.
Topic Author
hoeboe
Posts: 62
Joined: Tue Jul 06, 2010 10:43 am

Re: Distributions from non-qualified deferred comp plan

Post by hoeboe »

Soon2BXProgrammer wrote: Tue Oct 13, 2020 9:28 am
hoeboe wrote: Tue Oct 13, 2020 7:32 am 1) When distributions occur, what taxes will be withheld? Obviously federal income taxes (no state for me). What about SSDI? Medicare?

2) What is the expected federal withholding rate? Each lump sum will be about 80k-120k. Since each comes in a single "paycheck" are withholdings at the 22% supplemental rate? I expect to be in a much lower tax bracket so I expect to owe little taxes on the distribution. I know any over withholding will be resolved after filing tax returns, but I don't like the idea of waiting a year for >$10k refunds.

3) Does the distribution count as earned income? Can it be used to fund non-taxable IRAs? Roth IRAs? HSA (I will be in a retiree HDHP supplemented by my employer)?

4) Any other "gotchas" with distributions?

Thanks!
1) In most plans, as long as your SS and Medicare was already withheld (normally it is), then no SS and no Medicare.

2) It will be withheld at the 22% rate. (they don't know if you are going to work another job)

3) No it doesn't count as earned income for IRA/Roth IRA. From IRS Pub 590-A (your NQDC distribution should be in both box 1 and box 11 of a W2)
Wages, salaries, etc.Wages, salaries, tips, professional fees, bonuses, and other amounts you receive for provid-ing personal services are compensation. The IRS treats as compensation any amount properly shown in box 1 (Wages, tips, other compensation) of Form W-2, Wage and Tax Statement, provided that amount is reduced by any amount properly shown in box 11 (Nonqualified plans). Scholarship and fellowship payments are compen-sation for IRA purposes only if shown in box 1 of Form W-2.
the HSA is a a different story, there is no earned income requirement for HSA contributions, therefore you can save in an HSA.
Thanks for the great details and succinct response! The information the employee handbook is scant and hard to locate.
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FiveK
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Re: Distributions from non-qualified deferred comp plan

Post by FiveK »

If your employer treats the payment as "supplemental wages" they will likely withhold a flat 22% (regardless of whether the payment is paid monthly, annually, or whatever) so you might be giving the IRS an interest-free loan and get that back as a refund when you file.

If you would rather have your money during the year, there may be nothing you can do in the year you retire and the next year. After that, however, (see p. 19 of https://www.irs.gov/pub/irs-pdf/p15.pdf) your employer must use whatever withholding you request on a W-4: "If you didn't withhold income tax from the employee's regular wages in the current or immediately preceding calendar year, use method 1b."

Payroll departments may be unaware of this, but if you qualify and point out to them what the IRS law is, you can probably persuade them to do what you want. :)
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