Deferred compensation--what is it?

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jegallup
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Deferred compensation--what is it?

Post by jegallup »

Well I think I know what it is literally. Is it always an individual agreement between an employee and the employer, or a company-wide program? What are the tax implications?
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Post by Grandma »

In my work we use deferred compensation as a generic term for an employee's defined contribution (DC) plan such as a 401ks, 403bs, 457s, etc.

It can be distinguished from a defined benefit plan, which is the old fashioned pension so rare today---employees may, but often don't, actually contribute to the DB plans. If you have one of these, you're lucky indeed.

Best.
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Post by Buysider »

http://www.bogleheads.org/forum/viewtop ... highlight=

This was a discussion from a while ago that has some information about deferred compensation plans - these are different from defined contribution plans, which are generally covered under ERISA legal regulations.
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Re: Deferred compensation--what is it?

Post by BruceM »

jegallup wrote:Well I think I know what it is literally. Is it always an individual agreement between an employee and the employer, or a company-wide program? What are the tax implications?
"Deferred Compensation" is a broad term that generally means that the employer promises to pay future benefits in excess of the qualified retirement plan being offered.

With the exception of Government 457(b) plans, this is really a promise to pay, that is not enforceable by the IRS or ERISA (Dept of Labor). Its a contractual agreement between select employees and the employer.

Distribution from the plan at retirement will be ordinary income to the former employee and is then deductible as a labor cost by the employer.

Deferred comp can be entirely discriminatory, although it must now be a written plan that spells out when the accrued benefits are payable (actually, when the employee is in constructive receipt).

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Post by jegallup »

Thanks to all who answered. The old thread was also very informative, and I should've searched for it.
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Post by Grandma »

Ah, I see now that you were actually asking about high earner compensation issues.
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Post by LadyGeek »

Now added to the wiki. Please see Deferred Compensation on the Bogleheads Wiki.

Comments / corrections are welcome.
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Post by mas »

LadyGeek wrote:Now added to the wiki. Please see Deferred Compensation on the Bogleheads Wiki.

Comments / corrections are welcome.
Grandma & BruceM alluded to it, but "deferred compensation" really includes other types of things (401k, 457, etc...), while most people really mean "non qualified deferred compensation".

Here are a few more threads if you want to add any more details to the wiki:
http://www.bogleheads.org/forum/viewtopic.php?t=6084
http://www.bogleheads.org/forum/viewtopic.php?t=23803
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Post by LadyGeek »

From my perspective (newbie), the concept of qualified vs. non-qualified simply determined the type of deferred compensation, not the definition itself.

IOW, Qualified means the IRS won't get its cut until withdrawal time. Non-qualified means the IRS takes its cut now.

Your links talk about another variation - Non-Qualified Deferred Compensation with a number of advantages / disadvantages. Is this a separate topic, perhaps for a new wiki page?

BruceM's comment seemed like a minor point compared to getting the "basic" definition figured out.
BruceM wrote:"Deferred Compensation" is a broad term that generally means that the employer promises to pay future benefits in excess of the qualified retirement plan being offered.

With the exception of Government 457(b) plans, this is really a promise to pay, that is not enforceable by the IRS or ERISA (Dept of Labor). Its a contractual agreement between select employees and the employer.

Distribution from the plan at retirement will be ordinary income to the former employee and is then deductible as a labor cost by the employer.

Deferred comp can be entirely discriminatory, although it must now be a written plan that spells out when the accrued benefits are payable (actually, when the employee is in constructive receipt).
What is meant by "in excess of the qualified retirement plan being offered"? I get the impression that this is written from the employer perspective.

Is a 401(k) plan deferred compensation? I thought 401(k) contributions were not at risk if the company fails- if I'm vested and don't include the company stock.

Does the wiki page need updating? I like to put helpful insight above and beyond the basic stuff, but I'm not sure what to do.
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Post by Grandma »

Lady Geek: Yes, a 401k plan is also considered 'deferred compensation'.
A 401k is a defined contribution (DC) plan.
'Deferred compensation' is also a generic term for several different things.
(I'm not a tax expert qualified to define and distinguish the fine points under the IRC.)

Best. Grandma
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Post by mas »

LadyGeek wrote:From my perspective (newbie), the concept of qualified vs. non-qualified simply determined the type of deferred compensation, not the definition itself.

IOW, Qualified means the IRS won't get its cut until withdrawal time. Non-qualified means the IRS takes its cut now.

Your links talk about another variation - Non-Qualified Deferred Compensation with a number of advantages / disadvantages. Is this a separate topic, perhaps for a new wiki page?
I'm not an expert myself - so somebody correct me...

I'd say that "Non-Qualified Deferred Compensation plans" are a subset of deferred compensation plans, but that when people (like in this post) use the phrase "deferred compensation", they are really talking specifically about non-qualified plans - because the qualified plans have more specific names.

As for "qualified" vs "non-qualified"... I'm not sure, that is some type of IRS speak, but "non-qualified" plans DO keep tax deferral until the money is distributed at a later time, just like qualified plans.
LadyGeek wrote:What is meant by "in excess of the qualified retirement plan being offered"? I get the impression that this is written from the employer perspective.
For example, an employee can defer $16.5K/yr into a 401k (their qualified plan), if the employee defers more than that, it has to go into a non-qualified plan. And those plans need additional restrictions in order to successfully keep the IRS at bay.
LadyGeek wrote:Is a 401(k) plan deferred compensation? I thought 401(k) contributions were not at risk if the company fails- if I'm vested and don't include the company stock.
I believe that it is deferred compensation. The rules for the money needing to be "at risk" refers to non qualified plans.
These may or may not be helpful:
http://www.irs.gov/taxtopics/tc424.html
http://www.irs.gov/retirement/article/0 ... 22,00.html
LadyGeek wrote:Does the wiki page need updating? I like to put helpful insight above and beyond the basic stuff, but I'm not sure what to do.
I was hoping that someone would chime in to validate my statements (or show me up).

I think that the part in bold on the wiki is essentially correct, while the two non-bolded paragraphs are really specific to non-qualified plans.
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Post by Grandma »

I think this is a very technical area governed by ERISA, IRC, etc.
There are issues/problems with 'top heavy' high earners, etc. which I believe also dovetails into the discussion if expanded.

I would suffice it to say that 'deferred compensation' is a broad and generic term which may include 'qualified' and 'non-qualified' salary/compensation deferral.
Define 'qualified' and 'non-qualified', and provide examples:.
Examples are high earner.............blah, blah, blah, non-qualified........
401k, 457, 403b qualified defined contribution plans...........

Maybe there are others on the board with expertise and more precision in this area; my exposure is tangential.

Perhaps that helps a bit.
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Post by yobria »

DC generally means:

A special plan whereby company managers/execs can defer some % of their income until separation of service, up to 100%. If the exec is a certain age when he leaves, he gets an annuity payout. If not, a fully taxable lump sum. The comp can be invested in mutual funds while it sits.

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Post by BruceM »

Lets me see if I can explain this a bit more thoroughly

Yes, in its broadest sense, "Deferred Comp" could mean any form of long term savings, including sick leave, IRA contributions or home equity for that matter. But through employers, the name denotes a non-qualified "promise to pay" on the part of the employer, in many, many forms, which often include the increased valuation of the company's stock, measures of executivie performance, cash value built in life insurance, salary increases/bonuses for the next year not paid by the employer but kept in a company trust, and so on. (note: there is such a thing as a 'funded' Deferred Comp plan utilizing a 'Secular Trust' that does require ERISA compliance...but they are rare and its really another topic)

Qualified plans and Deferred Compensation Plans, other than the general goal of setting aside assets today to be paid out to the employee in later years. have NOTHING in common. The former are tightly regulated with literally thousands of pages of IRS and ERISA code governing every aspect of their existence. The latter have virtually no regulation, other than requiring the plan's payout schedule to be written and limiting accellerated payouts or contributions during periods when the company's qualified plans are underfunded.

This is why Deferred Comp is so hard to describe, as it is whatever the employer calls it...and as I mentioned earlier, it is really about contract law: a written agreement between an EE and ER, not statutory law administered by the DOL and IRS, that governs qualified plans.

But the most common type of Deferred Comp that I've had experience with "stack" on top of the company's qualified plan....generally referred to as "Excess Benefit Plans", although every employer seems to have their own name for it. For certain employees, the employer will allow additional contributions or benefits to be made to the Deferred Comp plan that begin where the qualified plan ended (the Deferred Comp plan must now clearly define this in writing). There is no rhyme or reason to this...only what the employer considers to be a good strategy for rewarding/retaining valued employees. And it is imperitave that each participating EE understand that the assets set aside in the Deferred Comp plan are nothing more than the employer's promise to pay them at a future date...and this promise is only as good as the employer's ability to keep it, unlike qualified plans, where vested account balances are 100% owned by the EE regardless of ER status.

Hope this helps to clarify

BruceM
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Post by LadyGeek »

everyone - thanks for the additional insight, including examples and IRS links.

There's enough material to give it a full page on the topic. I'll post back when the update is done.

Like the OP, I never really understood, nor realized all the details, of what deferred compensation was. Writing a wiki page helps me to understand the concept while simultaneously helping anyone else who reads it.
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Post by LadyGeek »

Upon further review, I think I see another way to work this. "Deferred Compensation" was the question, but the answer was Employer Provided Retirement Plans.

Has anyone seen the IRS Retirement Plans Navigator? It's got all the basic definitions you need, including this really enlightening Plan Comparison Table. Everything in one fell swoop.

There even a link to the Department of Labor's (huh?) Types of Retirement Plans which gives concise definitions and examples of deferred compensation vs. defined contribution plans.

I think the wiki needs some work in this area and this might be a good way to go - link everything together from the "big picture". I'll use the IRS / DOL definitions to start.

I also updated the Deferred Compensation wiki page to remove the references to the non-qualified plans.
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Post by jegallup »

LadyGeek wrote:Department of Labor's (huh?)
A CPA friend says they have jurisdiction over some aspects of retirement plans because they involve wages.
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Post by LadyGeek »

That would make a lot of sense. I found the link on the IRS site for Defined Benefit Plan. Maybe the DOL has more to say on the matter.
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Post by LadyGeek »

The wiki has been updated. Please see Employer Retirement Plans Overview on the Bogleheads Wiki.

I started a new thread on the topic: http://www.bogleheads.org/forum/viewtop ... 43&start=0
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Post by Flashes1 »

Most people don't realize that deferred comp. holders are considered unsecured creditors in bankruptcy. Many Lehman employees lost millions as a result.
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Post by Wagnerjb »

Flashes1 wrote:Most people don't realize that deferred comp. holders are considered unsecured creditors in bankruptcy. Many Lehman employees lost millions as a result.
So did the Enron executives. If you have a deferred comp plan (a non qualified one), you better understand this risk.

Best wishes.
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Post by BruceM »

Wagnerjb wrote:
Flashes1 wrote:Most people don't realize that deferred comp. holders are considered unsecured creditors in bankruptcy. Many Lehman employees lost millions as a result.
So did the Enron executives. If you have a deferred comp plan (a non qualified one), you better understand this risk.

Best wishes.
As did Lee Iacocca, who lost his deferred comp when Chrysler filed for bankruptcy..

Actually, the Enron crooks (Kenneth Lay, Andy Fastow and Jeff Skilling) accellerated distributions from the DC plans as they saw the house of cards start to collapse. Their actions were one of the driving forces in getting Congress to pass Sect 409(a) to prevent executives from acellerating DC withdrawals, as well as other restrictions.

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Post by LadyGeek »

BruceM - Your comments are in the Employer Retirement Plans Overview page, under "Deferred Compensation" plan. It helped a LOT. Thanks!

Let me know if you want to change anything in this thread: http://www.bogleheads.org/forum/viewtop ... highlight=
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Post by BruceM »

LadyGeek wrote:BruceM - Your comments are in the Employer Retirement Plans Overview page, under "Deferred Compensation" plan. It helped a LOT. Thanks!

Let me know if you want to change anything in this thread: http://www.bogleheads.org/forum/viewtop ... highlight=
Lady
The deferred comp description looks fine

I'd suggest modifying the 457 description a bit, though.

457 plans are deferred comp plans, and may be in addition to the employer's qualified plans. There is no 10% early withdrawal penalty if one is not yet 59.5, and there are special 'catch-up' provisions for those within 3 years of the 457(b) plan's retirement age (see below)

Government 457(b) plans MUST be funded, as you've indicated when you identified the vested account balances as being held 'for the exclusive future benefit of the employee' note: this is the definition of the doctrine of 'economic benefit', something unfunded deferred comp may not have, or it would be income to the employee.

As you've noted, non-profit (excluding churches) organizations may offer a 457(b) plan that CANNOT be funded. Note, that this doesn't mean the employer may not set aside funds in trust with the intent to pay them out to the employee in future years....'unfunded' simply means there may not be a 'economic benefit', which almost always means that the employer must hold them as assets to the NP organization, subject to the claims of their creditors. This also generally means that plans balances are not transferrable between employers.

For both types of 457(b) plans, the maximum annual funding has the same limitations as qualified plans: for 2009 a maximum salary deferral of $16,500, with max $5,500 salary deferral catchup contribution if >= age 50. Note that this annual funding limitation may be in ADDITION to the employer's qualified plan or 403(b) plan contribution maximums. But in the final 3 years prior to the plan's designated retirement age, the employee may defer another max $16,500 as a catchup contribution, providing the employee has accumulated at least that much in all prior years that he/she contributed less that the maximum they could have contributed in each year. (note: the $5,500 catchup cannot be used if the final 3 year catchup is used)

Finally, 457(f) plans, or sometimes called 'ineligible' plans, are true deferred comp. for Governments and Non-profits, which both fall under the same rules and are typically reserved for the most highly compensated, such as the president of Goodwill Industries, the medical director of a hospital or a college football coach. There is no limit on annual plan contributions and the plan falls under the rules of section 409(a). As you might expect, there aren't too many of these out there.

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Post by LadyGeek »

I updated the 457(b) section with some of your comments. After reading the 457-b wiki page (and getting a bit bleary-eyed :? ), I think everything you said about contributions, catch-up contributions, and withdrawals is already there.

The details in the 457-b page are above my level of expertise (none!). I snagged the text from that page directly (in 2 spots) so I wouldn't duplicate the information and also that I wouldn't introduce any mistakes. If anyone makes changes in the 457-b page, it will show up here.

If you would like to make changes in the 457-b page, just post them here and I'll put them in (any wiki editor can do this for you as well).

As for the funding methods, I edited your comments to fit the context of the page and added a new sub-section.

I omitted your 457(f) plan because I need to limit the amount of information overload. If it's only for a few people, then it's probably not much benefit to put it in the wiki. If you think otherwise, it's not a problem. From my newbie perspective, I'm struggling enough with 15+ plans on that page... :confused

The purpose of the overview is to answer "What is this?". "How does it work?" is for the individual plan pages. There's a dedicated thread for the overview page: http://www.bogleheads.org/forum/viewtop ... 300#558300

Please see Employer Retirement Plans Overview on the Bogleheads Wiki.
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