Author Topic: Voluntary Deferred Compensation  (Read 4366 times)

dave__

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Voluntary Deferred Compensation
« on: October 05, 2015, 11:57:05 AM »
My wife's company has a voluntary deferred compensation plan available to employees who are eligible. We just became "eligible" (however that works) for next year. I am having trouble understanding what it all means. They use the term "investing" to describe the benefits but it does not state where this money actually goes. Can someone give me a quick rundown on how this works? Is it similar to a 401k? The $265,000 numbers/limits do not apply as she does not make that much money (I wish :) ). Thanks!

Here is the meat of the email that was sent:
Quote
We are pleased to offer you the opportunity to participate in the Voluntary Deferred Compensation Plan.  Enrollment begins Monday, October 5, and runs through Monday, November 2, 2015.

If you’re looking for a way to reduce your income taxes and take advantage of pre-tax investing, consider the Voluntary Deferred Compensation Plan.

Plan highlights:
1) Enjoy income tax deferral on your contributions and their investment earnings until they are paid to you.
→   Defer 5–50 percent of base salary earned in 2016 and/or
→   Defer 5–90 percent of the annual Management Incentive Plan award you may earn in FY16, that would be payable in 2016.
→   Defer 5–90 percent of total Excess Compensation. Excess Compensation is defined as base compensation plus annual incentive in excess of the IRC 401(a)(17) compensation limit. The compensation limit for 2015 is $265,000 and is subject to change annually.
IMPORTANT: If you make an Excess Compensation election, any Annual Base Compensation or Annual Incentive Award deferral elections will become null and void.
2) Meet your personal financial goals whether you want to retire early, pay for your child’s college education, or simply increase your net worth.
3) Grow your balance by choosing from a wide variety of crediting options.
4) Schedule withdrawals as early as 2017 to meet short-term needs.

Company Contribution and Match:
1) Company will contribute to your account 3% of your total annual compensation (including short-term incentive awards) that exceeds the IRC 401(a)(17) compensation limit ($265,000 for 2015).
2) Company will also match your deferrals up to 6% of your eligible compensation in excess of the IRC 401(a)(17) compensation limit in effect.

PathtoFIRE

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Re: Voluntary Deferred Compensation
« Reply #1 on: October 05, 2015, 12:55:58 PM »
Sounds like a non-qualified deferred compensation plan. I participate in mine, so I'll relay what I know.

Negatives
1.  These accounts look like other retirement accounts, in that you see contributions and matches, and you pick from a short list of investment options. However, they are not, although you'll want to read the plan documents for your wife's to be sure. My documents indicate that the company is under no obligation to actually invest the money they way I choose. While someone else may be able to chime in with some specifics, I believe that basically the deferred compensation essentially stays as company property, and that the accounts in your name are sort of a fiction, which are used to keep track of what they owe you. But you don't actually own the account, and in all likelihood there is not some separate pile of money/investments just for you. Instead, the program is funded by the company, the account managers are paid, and the company keeps a tally of what's supposed to be in there, and balances that with what it needs to pay out based on people leaving/retiring.
2.  Based on the first point, these accounts are risky. If your company goes bankrupt or possibly even undergoes some major change like buyouts, it's possible to lose some or all of the account value. Definitely do not put money in here that you may need in the short to medium term, and in reality, you should probably at least accept the small possibility that you will never see again.
3.  The investment options are often substandard with higher ERs than you would probably like.

Positives
1.  There is really only one, and that is to defer paying taxes on the contributions, matches, and capital gains in these accounts until some later point. The caveat is that you will have to take the account as earned income at some point. If you can do it in a year when you have little to no other earned income, great, but this requires that a) you probably need to be in a high marginal tax bracket when you make the contributions and b) you have at least some reasonable level of confidence that you can control your exit from the company.
2.  If you get matching, which your wife's plan does appear to do (mine has a different matching structure than your wife's), then that's potential additional income, not unlike the argument used regarding 401k, except that again, it's not really your money until you leave the company, retire, or otherwise trigger payment of the deferred compensation.

MDM

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Re: Voluntary Deferred Compensation
« Reply #2 on: October 05, 2015, 01:23:45 PM »
My wife's company has a voluntary deferred compensation plan available to employees who are eligible. We just became "eligible" (however that works) for next year. I am having trouble understanding what it all means. They use the term "investing" to describe the benefits but it does not state where this money actually goes. Can someone give me a quick rundown on how this works?
First, congratulations to your wife - she must be doing well indeed.  Also, this will be similar to PathtoFIRE's post.  Already started it before that post, so....

This appears to be a "Non-Qualified Deferred Compensation" plan.  E.g., see https://www.fidelity.com/viewpoints/retirement/nqdc or other sites you might find by searching with those terms.

As these plans are a contract between the employer and the employee, there is no "standard" and you do have to read the fine print for your specific plan.  Again, this is a promise from the employer to pay the employee some amount-to-be-determined in the future, in return for not having to pay the employee today.

That amount is often determined by treating the deferrals as if they are invested in a variety of options the employee can select.  The options may include index funds, US Treasuries, target date funds, etc.  The "fees" may be high, but they also may be low because these plans are particularly targeted for the CEO crowd and as they get to choose....  You might even be able to log on to a website that looks very similar to your 401k or taxable account and see "your investments."  Those "investments" don't exist in that form - what you see is the total amount your employer currently promises to repay.

The big potential upside is the tax-free investment and growth of much more than the $18K 401k limit.  As with a 401k, you would be taxed when withdrawing.  Unlike (and better than) a 401k, you can start withdrawals without penalty at a time of your choosing.  You may, however, have to make that choice some years in advance.
The big potential downside is the loss of all your investment if the company goes bankrupt.

Anyway, read the fine print and make your choice.  Definitely a risk/reward situation that might or might not work very well for you.  The longevity of the employer is the largest unknown factor.

kkbmustang

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Re: Voluntary Deferred Compensation
« Reply #3 on: October 05, 2015, 02:05:32 PM »
I will echo the congrats - these types of arrangements are generally reserved for the top levels of management. And they are called nonqualified deferred compensation arrangements because they do not have to meet the requirements for qualified plans in Code section 401(a), such as 401(k) plans. Qualified plans get tax preferences (immediate employer deduction, delayed income inclusion until distribution for employees) that NQDC plans don't (deduction for the employer at the same time employee recognizes income). Yay for deferral of taxes and additional matching contributions. Boo for it not being secured.

A few important points:
1. These arrangements are subject to the limitations set forth in Internal Revenue Code section 409A. Why you should care: if the plan, either in form or operation, doesn't comply with 409A (including deferrals and distribution options), the EMPLOYEE will be subject to immediate income inclusion, excise taxes and interest. Some states (like California) also impose a similar excise tax. So, look at the plan document and/or deferral agreement to make sure that there is a 409A savings clause. In other words, a provision that states the company will be on the hook for any excise taxes and/or interest and other penalties for a failure to comply with 409A.

2. See if there is accelerated vesting and distribution on a Change in Control. If the definition of Change in Control in the plan or deferral agreement does not comply with the definition of a CIC in the 409A regs, that will bust it triggering the excise tax. Also make sure your wife understands every distribution provision - what is the definition of CIC, Good Reason termination, etc.

3. These arrangements can either be tracked in a notional account of the employer as described already OR the employer can sponsor a rabbi trust (it's a long story why they are called a rabbi trust) in which the funds will be held. In either scenario, if the employer goes bankrupt, its creditors will be in line BEFORE employees with nonqualified deferred comp promises. So, if there is any concern about the viability of the company, think carefully.

thingamabobs

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Re: Voluntary Deferred Compensation
« Reply #4 on: October 05, 2015, 03:20:17 PM »
So my company just got bought out by another company and our 401K match is going away. The new company offers a voluntary deferred income plan, but sounds like we do get a choice in the investments (Charles Schwab is the investment company). My hesitation with participating would be:

1. The deferred income is considered company asset until distributed, and like others have said creditors come first. While I don't believe the company has any struggles financially, one never knows.

2. Lots of restrictions regarding changes. Any changes to the plan A) does not take effect until 12 months after the change B) must be made at least 12 months before original distribution date C)new election MUST delay distribution by at least 5 years from the original payment date!!!!

I'm sad to lose the match but I don't think this is a good alternative at all! Any thought?

kkbmustang

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Re: Voluntary Deferred Compensation
« Reply #5 on: October 05, 2015, 04:22:00 PM »
So my company just got bought out by another company and our 401K match is going away. 


Are you fully vested in the matching contributions in your company's 401(k) plan (i.e., the target company, not the acquiring company)? If not, you might want to consider keeping your funds in the plan, even if you quit working for the company in the future, IF you think it's possible the new company will terminate that 401(k) plan. If a qualified plan is terminated, all participant matching (or profit sharing) contributions must be fully vested.

The new company offers a voluntary deferred income plan, but sounds like we do get a choice in the investments (Charles Schwab is the investment company).


You can give the sponsor of the plan suggestions as to how to invest your (nonqualified deferred compensation) assets, but they are not obligated to follow your wishes. In practice, the company usually does, but they don't HAVE to. If they allow the employee to have control over the assets in this way (among others), the IRS can argue that the employee is in constructive receipt of the assets, thereby triggering income recognition for tax purposes.

My hesitation with participating would be:
1. The deferred income is considered company asset until distributed, and like others have said creditors come first. While I don't believe the company has any struggles financially, one never knows.

Yes, this is the rub. You're taking on that risk in exchange for not recognizing income now.

2. Lots of restrictions regarding changes. Any changes to the plan A) does not take effect until 12 months after the change B) must be made at least 12 months before original distribution date C)new election MUST delay distribution by at least 5 years from the original payment date!!!!

Yes, there are tons of restrictions. They were implemented for a variety of reasons, including because the IRS wants its tax revenue. Individuals are generally cash basis taxpayers (i.e., income is recognized when received or constructively received) and NQDC was basically invisible to the IRS since it wasn't recognized by the taxpayer until it was paid. The IRS didn't want taxpayers to be able to defer their income indefinitely, so they put lots of restrictions on it and slapped a 20% excise tax on top.

I'm sad to lose the match but I don't think this is a good alternative at all! Any thought?

It totally depends on you, your tax situation, the stability of your company, and whether there are any additional benefits the company will kick in on top.

dave__

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Re: Voluntary Deferred Compensation
« Reply #6 on: October 15, 2015, 08:35:36 AM »
Thanks for the congrats, although she is definitely not "upper" management. Her company offers this to employees that make a certain salary which is no where near Executive level compensation.

We are going to have to think this over as I'm leery of the unsecured part. Her company is going through lots of changes currently (new CEO, selling part of the business, re-orgs/layoffs, etc.) Maybe we'll do the minimum to get the match as it's "free money" :)

PathtoFIRE

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Re: Voluntary Deferred Compensation
« Reply #7 on: October 15, 2015, 11:08:52 AM »
Yeah, it's a tough decision. This past year is the first time I've contributed up to the maximum matching contribution. If I'm able to successfully negotiate the raise I'm planning, I've been thinking about going over that limit next year as I've run completely out of other tax-deferred space and do not have access to the Megabackdoor Roth (as an aside, I would have your wife look into her eligibility for this, as it's still aftertax contributions, but they get tax-deferred growth; having this option would make me seriously rethink using the deferred comp plan).

Those are helpful points kbbmustang, it got me to go back through my plan document. Regarding change in control, my plan says "A Participant shall also become 100% vested in his or her Matching RSU Contributions Account upon a change in control (within the meaning of IRC Section 409A)." which looks good, and then goes on to give am example of when that happened in 2007. Can't find anything about a savings clause, so it looks like I'm on the hook for any penalties and taxes if the plan violates 409(a).

kkbmustang

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Re: Voluntary Deferred Compensation
« Reply #8 on: October 25, 2015, 01:57:36 PM »
Can't find anything about a savings clause, so it looks like I'm on the hook for any penalties and taxes if the plan violates 409(a).

It would say something like notwithstanding any provision to the contrary, should the terms of the plan fail to meet the requirements of Code section 409A such that an excise tax is triggered, the Executive shall be made whole by the Company to the extent any such benefits are subject to any taxes, penalties and/or interest.