Is Deferred Compensation Program Risky?

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enlightenmeplease
Posts: 1
Joined: Thu Nov 07, 2019 8:37 am

Is Deferred Compensation Program Risky?

Post by enlightenmeplease » Thu Nov 07, 2019 8:57 am

I was on another forum today and was told that investing in our company's deferred comp program is risky. Right now we have about $500K in deferred compensation account of a large secure organization which has steadily grown over the past 100 years (both as a private and now public organization). The program allows husband to defer a portion or his entire bonus. The past two years, we have deferred the entire bonus, which is about half of his total compensation. The advice this person is giving us is to not participate "because you never know when the company can go out of business." However, this would kill us from an income tax perspective. Husband will be retiring in the next 5 years. Should we discontinue participation in this program?

A little background on our financial situation:
Compensation is $800K (including bonuses)
Asset Allocation is as follows:
--$2.2M company stock and options
--$2.4M investments (after tax)
--$2.6M in 401K and other retirement funds
--$600K home equity
--$500K 529 plan
--$100K cash

ryman554
Posts: 1231
Joined: Sun Jan 12, 2014 9:44 pm

Re: Is Deferred Compensation Program Risky?

Post by ryman554 » Thu Nov 07, 2019 10:42 am

enlightenmeplease wrote:
Thu Nov 07, 2019 8:57 am
I was on another forum today and was told that investing in our company's deferred comp program is risky. Right now we have about $500K in deferred compensation account of a large secure organization which has steadily grown over the past 100 years (both as a private and now public organization). The program allows husband to defer a portion or his entire bonus. The past two years, we have deferred the entire bonus, which is about half of his total compensation. The advice this person is giving us is to not participate "because you never know when the company can go out of business." However, this would kill us from an income tax perspective. Husband will be retiring in the next 5 years. Should we discontinue participation in this program?

A little background on our financial situation:
Compensation is $800K (including bonuses)
Asset Allocation is as follows:
--$2.2M company stock and options
--$2.4M investments (after tax)
--$2.6M in 401K and other retirement funds
--$600K home equity
--$500K 529 plan
--$100K cash
You are worried about deferring $500k in income (which do go away if the company goes under) and are *not* worried about the $2.2M in company stock that will go to zero faster than your deferred compensation will?

I get the income tax hit is painful. It's probably 50% or so. But you *should* diversify/sell as much company stock as possible. That's at more of a risk than your deferred compensation.

Do that, and you are all set, unless your lifestyle is large, regardless of what happens to your deferred compensation.

chevca
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Joined: Wed Jul 26, 2017 11:22 am

Re: Is Deferred Compensation Program Risky?

Post by chevca » Thu Nov 07, 2019 11:17 am

Which deferred comp. program are you asking about? The company stock, the 529, a 457b, or...?

dcabler
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Joined: Wed Feb 19, 2014 11:30 am

Re: Is Deferred Compensation Program Risky?

Post by dcabler » Thu Nov 07, 2019 12:16 pm

The main risk is of a deferred compensation plan is that in the case of bankruptcy, you are just another creditor to be paid off and most likely not at the top of the list to be paid. There are some protections for this (google "rabbi trust"), but it is not absolute.

In my case, there was also something I hadn't considered. I was planning on staying with a previous employer until retirement and then, having left the company, payouts would begin the following January to be paid over 10 years, presumably when I was in a lower tax bracket. However, I was layed off from the company well before I planned on retiring and the checks started the following January, with no way to stop them due to some restrictions in the plan. So I'm now getting these checks every January, well before I wanted to and, of course, I'm paying taxes at my current rate. Not what I was hoping for. Glad I was only in the program for a few years before I was layed off so the total amount wasn't horrendous. And after this January, only 2 more checks and I'm done with this.


Cheers

HomeStretch
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Re: Is Deferred Compensation Program Risky?

Post by HomeStretch » Thu Nov 07, 2019 12:29 pm

Agree with dcabler’s points. Is there a company match? Evaluate the financial health of the company sponsoring the plan. Read the plan to understand the payout terms in the event of termination, death or change of control.

Spouse was in a Deferred Compensation Plan for a MegaCorp that entered into bankruptcy in the last downturn due to cash flow issues caused by major customers cancelling custom orders (in production or finished goods warehouse) overnight in a hard hit industry. Luckily MegaCorp reorganized and came out the other side so no loss of plan funds. But when MegaCorp was acquired a few years later, the terms called out for immediate payout of all deferred comp plan balances. So we paid taxes at the highest rate as spouse also received severance, had a new job, etc. The company match helped offset the additional taxes.

not4me
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Re: Is Deferred Compensation Program Risky?

Post by not4me » Thu Nov 07, 2019 1:49 pm

enlightenmeplease wrote:
Thu Nov 07, 2019 8:57 am
Husband will be retiring in the next 5 years. Should we discontinue participation in this program?

Riskiness, imo, is tied to viability of the company & then to how you have remainder of your assets invested. As pointed out, details of the plans vary. I've known it to be very good, but also not so good. Some place the funds for this in a separate trust & wouldn't be in trouble even if bankruptcy. "Investment options" vary, payout periods etc. So, look at what you'd do in various "bad case' scenarios. What happens if company folds in 2 years? 7 years (2 years after retirement)? Can you exit some/all of company stock/options -- which may have same/similar risk instead of dropping the tax deferral? Then it is a matter of your risk tolerance

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Stinky
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Location: Sweet Home Alabama

Re: Is Deferred Compensation Program Risky?

Post by Stinky » Thu Nov 07, 2019 4:44 pm

ryman554 wrote:
Thu Nov 07, 2019 10:42 am

You are worried about deferring $500k in income (which do go away if the company goes under) and are *not* worried about the $2.2M in company stock that will go to zero faster than your deferred compensation will?

I get the income tax hit is painful. It's probably 50% or so. But you *should* diversify/sell as much company stock as possible. That's at more of a risk than your deferred compensation.

Do that, and you are all set, unless your lifestyle is large, regardless of what happens to your deferred compensation.
This!

You have a great deal of exposure to this employer. About 1/3 of your financial assets in company stock, plus another $500k in deferred comp.

I'd definitely lighten up on company stock if I were you. A lot. And I wouldn't suggest deferring any more income with the employer.
It's a GREAT day to be alive - Travis Tritt

DVMResident
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Re: Is Deferred Compensation Program Risky?

Post by DVMResident » Thu Nov 07, 2019 6:15 pm

dcabler wrote:
Thu Nov 07, 2019 12:16 pm
The main risk is of a deferred compensation plan is that in the case of bankruptcy, you are just another creditor to be paid off and most likely not at the top of the list to be paid. There are some protections for this (google "rabbi trust"), but it is not absolute.

In my case, there was also something I hadn't considered. I was planning on staying with a previous employer until retirement and then, having left the company, payouts would begin the following January to be paid over 10 years, presumably when I was in a lower tax bracket. However, I was layed off from the company well before I planned on retiring and the checks started the following January, with no way to stop them due to some restrictions in the plan. So I'm now getting these checks every January, well before I wanted to and, of course, I'm paying taxes at my current rate. Not what I was hoping for. Glad I was only in the program for a few years before I was layed off so the total amount wasn't horrendous. And after this January, only 2 more checks and I'm done with this.


Cheers
Funny, I always considered deferred comp plan as part of my lay-off/can’t find more work backup plan.

Another point is layoffs are not the only trigger for distribution. Acquisitions can also set them off (though each plan has its own quirks). So this is not an unusual risk.

Personally, I wouldn’t worry about it unless the account is very large. You save at the high margin and maybe you have to pay taxes at a high(er) margin. So a wash most of the time. It’s just a matter of figuring out what those tipping points are for the intolerably higher margin are. For my personal circumstances, I felt comfortable holding up $1m in deferred comp (which on a 10 year distribution would pay ~$100k/yr; never hit this number btw).

Back to the OP, I think $800k with a 5 year retirement time horizon is okay. However, I would look into the distribution scheme to see if there is a single lump distribution risk or if you can spread it out over 10 years (this being more common). Also, the employer stock is too concentrated-and is the item needing more attention than the defer comp tax risk.

123
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Re: Is Deferred Compensation Program Risky?

Post by 123 » Thu Nov 07, 2019 6:24 pm

I would curtail additional participation/contribution to the deferred compensation program with the employer as well diversify the positions you hold in the company stock. You are risking a various nice retirement to the actions and aspirations of those idiots you work with (you may know some of the idiots but you don't know all of the idiots).
The closest helping hand is at the end of your own arm.

dcabler
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Re: Is Deferred Compensation Program Risky?

Post by dcabler » Thu Nov 07, 2019 6:49 pm

DVMResident wrote:
Thu Nov 07, 2019 6:15 pm
dcabler wrote:
Thu Nov 07, 2019 12:16 pm
The main risk is of a deferred compensation plan is that in the case of bankruptcy, you are just another creditor to be paid off and most likely not at the top of the list to be paid. There are some protections for this (google "rabbi trust"), but it is not absolute.

In my case, there was also something I hadn't considered. I was planning on staying with a previous employer until retirement and then, having left the company, payouts would begin the following January to be paid over 10 years, presumably when I was in a lower tax bracket. However, I was layed off from the company well before I planned on retiring and the checks started the following January, with no way to stop them due to some restrictions in the plan. So I'm now getting these checks every January, well before I wanted to and, of course, I'm paying taxes at my current rate. Not what I was hoping for. Glad I was only in the program for a few years before I was layed off so the total amount wasn't horrendous. And after this January, only 2 more checks and I'm done with this.


Cheers
Funny, I always considered deferred comp plan as part of my lay-off/can’t find more work backup plan.

Another point is layoffs are not the only trigger for distribution. Acquisitions can also set them off (though each plan has its own quirks). So this is not an unusual risk.

Personally, I wouldn’t worry about it unless the account is very large. You save at the high margin and maybe you have to pay taxes at a high(er) margin. So a wash most of the time. It’s just a matter of figuring out what those tipping points are for the intolerably higher margin are. For my personal circumstances, I felt comfortable holding up $1m in deferred comp (which on a 10 year distribution would pay ~$100k/yr; never hit this number btw).

Back to the OP, I think $800k with a 5 year retirement time horizon is okay. However, I would look into the distribution scheme to see if there is a single lump distribution risk or if you can spread it out over 10 years (this being more common). Also, the employer stock is too concentrated-and is the item needing more attention than the defer comp tax risk.
Perhaps it's just my optimism, but I was pretty sure I'd find work quickly - which I did. If I were still working at the company and it happened today, then definitely it would be part of the plan since I'm 1's of years away from retirement.

MAR888
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Re: Is Deferred Compensation Program Risky?

Post by MAR888 » Thu Nov 07, 2019 9:05 pm

Other individuals considering participation in an employer's Deferred Comp Plan need to be sure they read the entire plan document to watch out for gotcha's that could be extremely impactful.

In my case, there were two aspects that I didn't fully understand about my firm's plan.

1. For each year's contributions (and gains), I was able to choose the payout schedule, for example over five years starting the year I left the company. BUT, if I were to leave the company before retirement age, the entire balance would pay out immediately as a lump sum. As noted by others, that is a bad tax situation to be in. In effect, that restriction could unfortunately keep an employee at a company after the point the individual was happy working there.

2. I had the flexibility to change the payout schedule for each year's contributions as long as the change occurred more than a year before distributions would have started AND as long as the change pushed the start date at least 5 years out. What I didn't realize is that after retirement, I was no longer able to change the payout schedule, period. That stipulation took away flexibility to continue to tax plan with other income after retirement.

mhalley
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Re: Is Deferred Compensation Program Risky?

Post by mhalley » Fri Nov 08, 2019 6:15 pm

Choosing the correct payout schedule is key in these types of plans. I agree that there is way too much risk tied to the company. I think investing in the deferred comp plan is reasonable if you feel the co is very strong, but I would drastically cut the company stock. Probably to 5% of equities. I would usually say 10, but the additional risk of the deferred comp plan made me cut it back.

milktoast
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Re: Is Deferred Compensation Program Risky?

Post by milktoast » Sat Nov 09, 2019 12:24 am

I defer all my comp and live by selling the company stock as soon as it vests. That’s the lowest tax burden in your bracket.

Given that you have allowed it to accumulate, it may be hard to sell without getting hit with taxes. But the stock you have held for a year is taxed lower than income. So at a minimum, shift from stock to nqdc by deferring and selling.

If a wipeout happens, you have to assume that the NQDC and the company stock and your job evaporate. In the case of NQDC, I’m saving 40% in taxes off the top - so it’s a risk I’m taking.

But there is no reason to think that I can pick a single stock (my employer) and have it beat the market. And the consequences for being wrong are more dramatic than rewards for being right.

I was all in taking most of my pay in stock and holding it from 96-2000. And got wiped out.

[edit - let me clarify. I very carefully compute the exact amount I can defer and still pay benefits, 401k max, Backdoor Roth, Espp, hsa, and all the other benefits plus the taxes on those benefits. Leaving only a few hundred per paycheck. Then defer the rest. Nqdc is like the worst benefit available to you, but at least for my employer it’s the first thing taken from your check. ]

anoop
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Re: Is Deferred Compensation Program Risky?

Post by anoop » Sat Nov 09, 2019 2:45 am

Stinky wrote:
Thu Nov 07, 2019 4:44 pm
I'd definitely lighten up on company stock if I were you. A lot.
Tell that to Gates, Bezos, and Zuckerberg!

aarondearu
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Re: Is Deferred Compensation Program Risky?

Post by aarondearu » Sat Nov 09, 2019 4:19 am

It’s a calculated risk that you have to decide if it’s worth it or not. If the company is stable and retirement is 5 years or less I would not have any concern about participating in a deferred comp program. There are many posts on this forum about NQDC plans and people have different opinions.

It would be helpful to try and figure out your taxes in retirement. Your taxable investments are producing about $60k in dividends a year. Then you will receive a deferred comp payout on top of that plus RMDs etc. You might not be saving as much in taxes as you think.

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Stinky
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Re: Is Deferred Compensation Program Risky?

Post by Stinky » Sat Nov 09, 2019 5:45 am

anoop wrote:
Sat Nov 09, 2019 2:45 am
Stinky wrote:
Thu Nov 07, 2019 4:44 pm
I'd definitely lighten up on company stock if I were you. A lot.
Tell that to Gates, Bezos, and Zuckerberg!
I’ll tell it to the thousands of former employees of Enron.
It's a GREAT day to be alive - Travis Tritt

l2ridehd
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Re: Is Deferred Compensation Program Risky?

Post by l2ridehd » Sat Nov 09, 2019 6:01 am

I deffered over 1 million in compensation from bonuses and I was with a company that even I considered risky. Lighten up on the stock and stock options. My biggest mistake was taking the 10 year payout vs a 3 or 5 year payout. I am now 74, still have 2 years left on payouts and because of these payments my medicare costs the maximum (about $450 a month), my RMD is taxed at a very high level. So there is good and bad that can come from this. My company was split into two and both sold. But my fund was transferred and is still being paid. I had some that paid as a result of the sale, but the operative word is still paid.

So bottom line, keep deffering as much as possible, take the payouts over as short a window as possible, and lighten up on company stock to lower exposure.

Valuethinker
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Re: Is Deferred Compensation Program Risky?

Post by Valuethinker » Sat Nov 09, 2019 9:03 am

enlightenmeplease wrote:
Thu Nov 07, 2019 8:57 am
I was on another forum today and was told that investing in our company's deferred comp program is risky. Right now we have about $500K in deferred compensation account of a large secure organization which has steadily grown over the past 100 years (both as a private and now public organization). The program allows husband to defer a portion or his entire bonus. The past two years, we have deferred the entire bonus, which is about half of his total compensation. The advice this person is giving us is to not participate "because you never know when the company can go out of business." However, this would kill us from an income tax perspective. Husband will be retiring in the next 5 years. Should we discontinue participation in this program?

A little background on our financial situation:
Compensation is $800K (including bonuses)
Asset Allocation is as follows:
--$2.2M company stock and options
--$2.4M investments (after tax)
--$2.6M in 401K and other retirement funds
--$600K home equity
--$500K 529 plan
--$100K cash
You are heavily exposed to the company's and the stock prices success.

I would look for the total exposure to deferred compensation plus stock to be 1 6th of total portfolio or less.

I also think at 800k that the formula of one third taxes one third savings one third living applies.

I realise taxes can be brutal but you appear to have housing costs under control so you should be able to do this.

milktoast
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Re: Is Deferred Compensation Program Risky?

Post by milktoast » Sat Nov 09, 2019 11:28 am

A little mental math on why I participate, taking my company risk in nqdc rather than holding company stock in taxable. In my plan, our nqdc funds can be “invested” and the company pays out eventually according to performance of your pretend portfolio.

So assume Dec 1, I have $100k in RSU vest and $100k in bonus. 40% marginal rate.

Option A - $60k in stock, $60k in cash. Spend cash hold stock.

Option B - $60k in stock, $100k in nqdc. Sell stock spend 60k. Have nqdc track sp500.

10 years later, I’m retired. 25% marginal rate, 15% capital gains. My company and sp500 both double.

Option A - 60k basis + 60k gains - 10k taxes. $110k

Option B - 100k basis + 100k gains - 50k taxes. $150k

So my company stock must beat sp500 by a lot to make option A better. And I’m a boglehead and don’t think I can stock pick.

But I believe in the company and will take the risk that they stay around long enough to pay my nqdc.

Anyway, that’s my argument for maxing nqdc if you are eligible and willing to take risk on the long term health of company.

shess
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Re: Is Deferred Compensation Program Risky?

Post by shess » Sat Nov 09, 2019 12:35 pm

anoop wrote:
Sat Nov 09, 2019 2:45 am
Stinky wrote:
Thu Nov 07, 2019 4:44 pm
I'd definitely lighten up on company stock if I were you. A lot.
Tell that to Gates, Bezos, and Zuckerberg!
At their current asset level, I'm mixed - if the company stock goes to zero, they'll be hurt, but they can survive. They'll just have to make big changes to their lifestyle, though they'll still be towards the 1% end of things.

But if they had twice as much in non-company assets, I wouldn't care less about how much company assets they have. The goal is financial independence, not the "right" ratio of company stock. The relevant fact isn't that Gates had 99.9% of his net worth in Microsoft, the relevant fact was that the .1% was more money than a normal person will ever see in their lifetime.

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