Deferred Compensation

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yobria
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Deferred Compensation

Post by yobria »

Deferred comp is a way for some or all employees of an organization to defer up to 100% of their income, earning a return on the dollars they would have paid in taxes, just like a 401k. Also like a 401k, deferred comp can reduce taxes paid, since taxable income can be smoothed between working (high tax bracket) and retired (low tax bracket) years.

DC appears to be growing in popularity - Wells Fargo (I just picked a company at random and read the 10-K) showed $2.7B in DC at the end of FY 2007, $4.3B in 2008.

Is DC a "good thing"? Given current budget deficits, should institutions receiving federal bailout money, or GSEs, or state and local government employees be able to engage in this particular type of (current year) tax avoidance? If it's offered to some employees, should all have the option? Can my plumber set up a DC plan and defer paying as much taxes as he wants?

Nick
xerty24
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Post by xerty24 »

I encourage everyone else to avoid using DC plans at all costs. Maybe that way the gov't won't have to raise my taxes. Also, you should all play the lottery and get your vaccines, so I don't have to.
kenbrumy
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Post by kenbrumy »

I have a DC plan where I work. The one risk of the plan is that once you have "deferred" your pay it becomes part of the assets of the corporation. You may have elected an investment into a mutual fund that performed well but; if the company goes under, you and everyone else with DC assets become big losers.

I have a nice chunk of money in mine and the company should not have any problems surviving. They may lay me off since business is slow but then I do get my money.

My DC assets are a small part of my total assets. I'd start to worry if it became "too much to lose." In effect, you're depending on your own company to survive. If it doesn't you lose your job and possibly a chunk of your savings.
Buysider
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Post by Buysider »

Can my plumber set up a DC plan and defer paying as much taxes as he wants?
In fairness, deferred comp plans are just reducing your current income. Anyone can do this. At the extreme, stop earning income = stop paying taxes.
Gekko
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Post by Gekko »

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dm200
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Post by dm200 »

If this is a private company (not a government agancy), I would be very concerned whether these funds that are "deferred" could disappear if the company went out of business, or was reorganizaed in a bankruptcy.
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Steelersfan
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Post by Steelersfan »

dm200 wrote:If this is a private company (not a government agancy), I would be very concerned whether these funds that are "deferred" could disappear if the company went out of business, or was reorganizaed in a bankruptcy.
That's true, so you have to consider both the risks and potential rewards. In my case I didn't start participating until about 6 years before I retired and elected to have it paid out to me starting shortly after retirement and over just a few years to minimize the risk. I also knew my company was a low risk to go bankrupt or I would not have elected to participate. If I was a younger employee and had to wait until I retired to get my money back I would not have participated either.
Last edited by Steelersfan on Sun Aug 30, 2009 8:55 am, edited 1 time in total.
George-J
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Re: Deferred Compensation

Post by George-J »

yobria wrote:... Is DC a "good thing"? Given current budget deficits, should institutions receiving federal bailout money, or GSEs, or state and local government employees be able to engage in this particular type of (current year) tax avoidance? .... Nick
For general background and self educational information you might want to go to the GAO website (United States Government Accountability Office) at www.gao.gov and read some of their reports on pension issues.

The most recent being the 77 page report on
PRIVATE PENSIONS -Alternative Approaches Could Address Retirement Risks Faced by Workers but Pose Trade-offs
and a bit from it ....
U.S. workers face a number of risks in both accumulating and preserving
pension benefits. Specifically, workers may not accumulate sufficient
retirement income because they are not covered by a defined benefit (DB) or
defined contribution (DC) pension plan. For example, according to national
survey data, about half of the workforce was not covered by a pension plan in
2008. Furthermore, workers covered by DC plans, in particular, risk making
inadequate contributions or earning poor investment returns, while workers
with traditional DB plans risk future benefit losses due to a lack of portability
if they change jobs. Preretirement benefit withdrawals (leakage), high fees,
and the inappropriate drawdown of benefits in retirement also introduce risks
related to preserving benefits, especially for workers with DC plans
.
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yobria
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Post by yobria »

Thanks for the responses all. If the company goes out of business, there's a risk you might not get your deferred comp. Got it. Beyond that, I guess my questions revolve around who gets it. Why is it offered only executives? It costs a company nothing (other than admin costs) to hold income in an account for a period of time. Should a postman be able to defer as much comp as he wants? Is this a tax loophole, or something employers should be encouraged to provide?

Nick
zeusrock1
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Post by zeusrock1 »

I contribute to my DC plan, but I work for the State. If the State has trouble and needs my DC money, I'm sure my pension is in trouble too so what the heck.

edit - I don't have a 401K option.
Last edited by zeusrock1 on Sun Aug 30, 2009 10:38 am, edited 1 time in total.
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IndependentlyPoor
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Post by IndependentlyPoor »

I have a friend who retired from Lyondell a couple of years ago and lost every cent of his deferred compensation when they went paws-up. It wrecked havoc with his retirement plans and now he might have to return to work.
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market timer
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Post by market timer »

Deferred compensation is not just about tax avoidance. It also creates an incentive to remain with an employer. In financial services, where it's relatively easy to move from one firm to another, DC is an important friction.
JW-Retired
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Post by JW-Retired »

yobria wrote: Why is it offered only executives? It costs a company nothing (other than admin costs) to hold income in an account for a period of time.
At my company it is offered to "highly paid employees." I don't know if that is an IRS term or just my company jargon. It can include lower level managers and upper level technical people. Not just executives. Limiting it only to higher pay catagories makes some sense since this money is at higher risk then that in 401Ks. Lower pay catagories have enough trouble just maxing out to their 401K limits anyway.

Possibly there is law controlling this?
JW
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ResearchMed
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Post by ResearchMed »

I think "DC" is being used for two different things here:
It started in this Topic as "Deferred Compensation".
It is recently used for "Defined Contribution" (vs. "DB", "Defined Benefit" - the old-fashioned "pension").

The Defined Contribution is received by the EmployEE, and invested in her/his name (and at her/his risk, etc.), often with restrictions on what investment choices are offered.

The Deferred Compensation is just that... deferred. It remains somewhere in the EmployER's coffers.
So yes, it is at risk if the firm goes bankrupt.
So is one's own "company stock" held in a 401(k), of course, which was really bad in the early 401(k) days when that was usually the *only* investment "choice" available.

I think it is ordinarily restricted to "high earners" (or it is where we are, anyway).
We aren't eligible for the Employer's Deferred Compensation plan (although our income is still high - not yet retired - most of it is from "consulting" and not from "earned income", so we use IRA/SEP-type tax-deferred methods in addition to the 403(b) available to all employees).

There are some ways of deferring compensation of one's own (such as sale's commissions) outside of formal Employer programs, but it's tricky, and if you don't file the right paperwork, there are tax penalties. (It's often a strategy used to postpone taxes, so the IRS wants to make sure that the income isn't just "forgotten" later when it is "claimed", as if taxes had already been paid.)

RM
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Post by Steelersfan »

yobria wrote:Thanks for the responses all. If the company goes out of business, there's a risk you might not get your deferred comp. Got it. Beyond that, I guess my questions revolve around who gets it. Why is it offered only executives? It costs a company nothing (other than admin costs) to hold income in an account for a period of time. Should a postman be able to defer as much comp as he wants? Is this a tax loophole, or something employers should be encouraged to provide?

Nick
I suspect it has to do with the fact that most companies that offer deferred compensation plans also offer 401K plans, and since most employees don't reach the contribution limits on those, there aren't that many lower paid folks for whom a deferred comensation plan is advantageous, especially given the risks noted here. A 401k has less risk, and with an employer match, is a much better investment for employees.

The advantages of a deferred compensation plan are less for lower paid people too, since their tax rate when they're employed is closer to what it will be when they're retired. That's less true for more highly compensated employees.
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Post by MossySF »

JW Nearly Retired wrote:
yobria wrote: Why is it offered only executives? It costs a company nothing (other than admin costs) to hold income in an account for a period of time.
At my company it is offered to "highly paid employees." I don't know if that is an IRS term or just my company jargon.
IRS jargon that probably comes from 401Ks. When 401Ks are top-heavy -- ie, too much contributions from "highly paid employees", the contribution limit can be decreased. For those who put the max in, this can be a huge hassle as once the plan is declared top heavy, everybody over the reduced limit gets contributions back and has to refile their personal taxes ... ugh.

So some companies might offer deferred compensation plans to highly paid employees to counterbalance their lower 401k limits.
dkturner
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Post by dkturner »

"Thanks for the responses all. If the company goes out of business, there's a risk you might not get your deferred comp. Got it. Beyond that, I guess my questions revolve around who gets it. Why is it offered only executives? It costs a company nothing (other than admin costs) to hold income in an account for a period of time. Should a postman be able to defer as much comp as he wants? Is this a tax loophole, or something employers should be encouraged to provide? "

Yobria,

I don't know about the practices of all companies, but the company for which I worked (and most that I'm aware of) restricts deferral of compensation to bonuses, and it's available only to employees who are classified as "highly compensated" (for 401k purposes) by the IRS. We have never been allowed to defer regular salary. As others have noted, one justification for deferred compensation is the limits the IRS places on 401(k) deferrals for highly compensated employees.
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Post by Dale_G »

My former employer started the deferred comp plan in 1995 because the 401k rules severely limited contributions from HCEs.

100% of pay excluding SS, medicare and health/life insurance could be contributed. Brave soul that I was, I contributed up to 70% of gross pay. The company contributed the small 401k company match to the DC plan.

Later, they dumped the pension plan and made payments to the DC plan in lieu of pension contributions.

I elected to receive (annual) distributions over 15 years after retiring. I avoided Federal, State and City taxes of more than 40% - and now much of the money is coming back in the 25% tax bracket. I am looking forward to distribution #11 in January, 2010.

Oh, the company is a very large two man partnership!
I hope the present big shots at the company have big investments in the plan.

Okay, there is risk, but life is full of risks.

Dale
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maywood
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Post by maywood »

My husband put all of his bonuses and as much salary as he could into his DC plan for 2001 & 2002. It has worked out great so far. The money would have been taxed at 39.6 or 35% but instead is being taxed at 25% as it comes out since he "semi-retired" in 2004.

If we hear that the company is in danger, we can take the money out with a 10% penalty. We deferred it for 10 years and are halfway through.

Maywood
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Post by On Approach »

I had a deferred compensation plan at my last employer - in addition to a 403(b) plan and 457 plan. The deferred compensation plan was mandatory for all employees - 2% of gross pay per pay period, then bumped up to 4% once past the SS maximum wage base. The plan was put in place in the early '90s when the DB retirement plan investments were doing so well that no employer or employee contributions were required. So the employee contributions went into the deferred compensation plan. The investment choices were the same as for the 403(b) and 457 plans - all Fidelity funds, the Vanguard REIT and SC Index funds, and a number of other low-expense proprietary funds. I was able to roll the balance over into my rollover IRA when I left employment.
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Post by Steelersfan »

maywood wrote:My husband put all of his bonuses and as much salary as he could into his DC plan for 2001 & 2002. It has worked out great so far. The money would have been taxed at 39.6 or 35% but instead is being taxed at 25% as it comes out since he "semi-retired" in 2004.

If we hear that the company is in danger, we can take the money out with a 10% penalty. We deferred it for 10 years and are halfway through.

Maywood
Just FYI , I'm pretty sure the regulations that allowed an elective withdrawal with a 10% penalty were changed so that any contributions after 2005 can no longer be withdrawn that way. Contributions prior to 2005 should be OK. There is a provision for a hardship withdrawal of post-2005 contributions with no penalty but I suspect that's not easy to get.

Oh, and in our plan if you terminated employment prior to retirement you got the whole balance as a lump sum. That normally would be contrary to shifting income to years with lower tax rates.

I'm not an authority on these matters but I do have the material I got as a participant over those years. That's how I read them.
Wagnerjb
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Post by Wagnerjb »

yobria wrote:Is this a tax loophole, or something employers should be encouraged to provide?

Nick
It is not a loophole. However, the plans cannot be as flexible as the standard 401k, otherwise the plan won't qualify for tax deferral. Contributions are limited, and the amount cannot be changed once it is declared (well in advance). Withdrawals plans must be set when the contributions are made, and are essentially impossible to modify.

Just look at this kind of plan like you look at other employee benefits. Some smaller companies don't offer very attractive employee benefits. Some don't offer a 401k plan. At some companies, executives get better benefits than non-executives. They get stock options, they get use of the company jet, they get supplemental life insurance, their bonuses are much bigger, etc.

Should employers be encouraged to provide such a plan? Make the plans legal, and let the employers judge the plans on the basis of cost-benefit, just like they do today.

Best wishes.
Andy
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Post by Steelersfan »

I happened across this item from IBM, which says they are going to offer their deferred compensation plan to all employees.

http://www.ibm.com/annualreport/2008/pr ... com9.shtml

IBM has a history of being a bell weather company for employee benefits. But they also have lots of highly compensation employees and an older than usual employee base, so what makes sense for them may not make sense for too many other companies.

I just don't think this will spread too far with the risks and restrictions placed on deferred comp plans as noted in this thread.
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Post by Chuck T »

Before I retired, I was a partner in a well known management consulting firm. We used deferred compensation as a method of retaining more capital in the business until the end of year distributions. It was a big plus for the firm as well as the employee. Chuck
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yobria
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Post by yobria »

Thanks all, interesting stuff.
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