Author Topic: Deferred Compensation Plans & State Income Tax  (Read 277 times)

ranchingretirement

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Deferred Compensation Plans & State Income Tax
« on: July 26, 2018, 07:51:00 AM »
Hello Mustachians!

I have a question regarding deferred compensation plans and state income taxes. I recently became eligible to participate in a DCP through my employer that would allow me to defer up to 80% of my compensation each year. The deferred compensation is held as "credits" that gain or lose value at the same rate as investments provided in our menu of options for 401(k) contributions. Essentially, participants become unsecured creditors of the employer and I realize that this brings added risk, although I have no concerns about the long-term health of the organization I work for. Participants can choose to receive their deferred compensation (which has hopefully gained in value along with the markets) in one of six ways:

1. Lump sum payout immediately after terminating employment - terrible idea, tax implications, etc.
2. Lump sum payout one year after terminating employment - again, not smart
3. Annual installments for five years starting immediately after terminating employment
4. Annual installments for five years starting one year after terminating employment
5. Annual installments for 10 years starting immediately after terminating employment
6. Annual installments for 10 years starting one year after terminating employment

I am interested in participating in this plan and see it as a great option for reducing taxes and maintaining income in the early years of retirement before my Roth conversion ladder kicks in. My only question is how long I should defer the income for. I currently live in California, but would likely be moving to a low/no state income tax state following retirement. I've read that if you defer compensation with annual installments for 10 or more years, the income is not subject to state income tax in the state it was earned (CA) but would instead be subject to tax rates in your state of residency in retirement.

I've also read that California no longer has a "source" tax law...could anyone here shed light on that specifically? Would I be able to choose the shorter deferment (five years) to cover the gap prior to my Roth conversion ladder and still avoid paying state income tax to CA?

Thank you for your insight!

px4shooter

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Re: Deferred Compensation Plans & State Income Tax
« Reply #1 on: July 26, 2018, 07:25:44 PM »
Definitely a Kali specific response will be needed. Hopefully someone will chime in.

Every one I read said they could not touch your income from the plan, since you are not a resident. Is the company one that is solely based in CA or are there other locations?

MDM

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ranchingretirement

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Re: Deferred Compensation Plans & State Income Tax
« Reply #3 on: July 26, 2018, 09:59:16 PM »
Thank you for your replies. MDM, it appears that the 10 year installments are specifically called out in the section of the tax code you referenced. Would I be subject to CA state income tax if I chose the 5 year option?

MDM

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Re: Deferred Compensation Plans & State Income Tax
« Reply #4 on: July 26, 2018, 10:46:04 PM »
Thank you for your replies. MDM, it appears that the 10 year installments are specifically called out in the section of the tax code you referenced. Would I be subject to CA state income tax if I chose the 5 year option?
Don't know.  I know you are safe with 10 year.

If you believe the payments are safe, option #6 makes sense: spreading them out over a longer time probably minimizes the marginal tax rates you'll pay.