Author Topic: 60% in TAX DEFEREED Comp - dumb to pass?  (Read 1757 times)

FIREME2020

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60% in TAX DEFEREED Comp - dumb to pass?
« on: December 01, 2017, 08:51:42 PM »

My company is offering me an opportunity to enroll in a non-qualified deferred compensation plan, in addition to my 401k, which I already max out. I can allocate up to 60% of my pay tax deferred! I'm unfamiliar with these plans and am a little nervous. Anyone familiar with them? Any downside I should be aware of? Am I just dumb for thinking about passing up on it?   I have a fairly high after tax savings rate so I can allocate some of that to the plan. Looks like the investment options are not the best but not horrible.  And average fee is 1.0%, much higher than VTSAX with .05%.  But TAX DEFERRED!  Am I dumb to not do it?

terran

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Re: 60% in TAX DEFEREED Comp - dumb to pass?
« Reply #1 on: December 01, 2017, 09:29:22 PM »
1% is a high fee, so part of this will have to depend on how big a difference there will be in your income (tax bracket) now vs when you withdraw.

The biggest issue with a non-qualified plan is that if something happens to the company "your" money is at risk, so the financial stability of your company is something you want to think about.

Also look into what the distribution options are and what your plans are for future employment. If the plan requires withdrawal as soon as you leave and you expect to work somewhere else at a similar salary before retiring then the deferral doesn't really help you much. Also be careful with the time frame over which the withdrawals have to happen as if the window is short and you defer "too much" you'll push yourself into a high bracket.


seattlecyclone

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Re: 60% in TAX DEFEREED Comp - dumb to pass?
« Reply #2 on: December 01, 2017, 09:43:17 PM »
Tax deferred until when? Something like this can be very valuable if it allows you to defer income from a high-earning year into a year when you're in a lower tax bracket (like the year you retire, for example). Otherwise it just doesn't seem all that compelling, especially if the investment options aren't very good.

FIREME2020

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Re: 60% in TAX DEFEREED Comp - dumb to pass?
« Reply #3 on: December 01, 2017, 09:51:40 PM »
Looks like I have a lot of flex on distribution. Any date I choose so long as it's at least 2 years out. Or I can choose retirement as the distribution date. Distribution can be lump sum or in installments.  When the time comes I can also deferred the distribution by 5 years if I don't need it.  But you're right Terran, I have to take the full lump sum if I leave the company.  Which I plan to do when I FIRE in a few years.  But until then it might still be beneficial to lower my current tax rate and have that money grow tax deferred? 

MDM

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Re: 60% in TAX DEFEREED Comp - dumb to pass?
« Reply #4 on: December 02, 2017, 12:18:30 AM »
Looks like I have a lot of flex on distribution. Any date I choose so long as it's at least 2 years out. Or I can choose retirement as the distribution date. Distribution can be lump sum or in installments.  When the time comes I can also deferred the distribution by 5 years if I don't need it.  But you're right Terran, I have to take the full lump sum if I leave the company.  Which I plan to do when I FIRE in a few years.  But until then it might still be beneficial to lower my current tax rate and have that money grow tax deferred?
Over relatively short times (e.g., "a few years") the tax deferral on dividends is small compared with many tax bracket differentials.  For example, if you contribute so much that a large fraction of the NQDC saves you only 15% now, but you pay 25% or more when withdrawing, it would have been better to use the mega backdoor Roth with that fraction (if the MBDR is available). 

This is the traditional or Roth decision on a large scale, and math that applies to a $5500/yr IRA decision also applies to a $35000/yr decision.

If all your NQDC contributions will save you a marginal rate of >30%, and you can spread withdrawals enough that you expect the marginal rate on withdrawals to be 25% or less, this should be a good deal.  With two caveats:
1) The financial health of the company, as already mentioned
2) Various forms of the new tax law being debated would eliminate NQDC benefits.  Probably worth asking your company benefits department "What happens if...?"

FIREME2020

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Re: 60% in TAX DEFEREED Comp - dumb to pass?
« Reply #5 on: December 02, 2017, 12:55:56 AM »
I'm not really worry about the financial health of the company. Though you never know, so yeah there's some slight nervousness. But from my understanding of the plan I can't spread the withdrawals once I leave the company, I must take the lump sum. If I stay until traditional retirement age then yes, I can spread across many years. But the goal is to FIRE in 2020, last thing I need is to sign up for golden handcuffs. 

Thanks Terran, Settlecyclone and MDM! I feel ok passing on this now!   


Retire-Canada

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Re: 60% in TAX DEFEREED Comp - dumb to pass?
« Reply #6 on: December 02, 2017, 08:12:40 AM »
But you're right Terran, I have to take the full lump sum if I leave the company.  Which I plan to do when I FIRE in a few years.  But until then it might still be beneficial to lower my current tax rate and have that money grow tax deferred?

So if you have to take the money lump sum in a few years is that really going to do much for you? You can't put in too much or you'll have a big tax bill when you get the lump sum.


gfirero

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Re: 60% in TAX DEFEREED Comp - dumb to pass?
« Reply #7 on: December 02, 2017, 02:26:31 PM »
I worked for a company that offered this, but I was just below the level in the organization where I could have taken advantage of it.  I had a few years of high comp, so I really, really wished I could have done it.  My tax bill was high in those rare years.

That being said, I did not do all the research to confirm it would have been a good deal for me.  I probably would have reached out to a CPA, or at least asked SeattleCPA to weigh-in :)

Good luck!

msheldon

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Re: 60% in TAX DEFEREED Comp - dumb to pass?
« Reply #8 on: December 02, 2017, 11:16:22 PM »
Check the lump sum distribution schedule. It's probably something like "6 months after you leave the company". This might be a nice way to give yourself an "income" for that first FIRE year if you can time your departure month appropriately.

terran

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Re: 60% in TAX DEFEREED Comp - dumb to pass?
« Reply #9 on: December 03, 2017, 07:48:29 AM »
I'm not really worry about the financial health of the company. Though you never know, so yeah there's some slight nervousness. But from my understanding of the plan I can't spread the withdrawals once I leave the company, I must take the lump sum. If I stay until traditional retirement age then yes, I can spread across many years. But the goal is to FIRE in 2020, last thing I need is to sign up for golden handcuffs. 

Thanks Terran, Settlecyclone and MDM! I feel ok passing on this now!

Since you're looking at only 2 years of contributions it wouldn't be too hard to figure out the amount to contribute to fill the lower brackets on withdrawal in 2020 (if you plan on quitting early enough in 2020 to have not filled them already).

ChpBstrd

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Re: 60% in TAX DEFEREED Comp - dumb to pass?
« Reply #10 on: December 03, 2017, 08:49:33 PM »
Tax deferred until when? Something like this can be very valuable if it allows you to defer income from a high-earning year into a year when you're in a lower tax bracket (like the year you retire, for example). Otherwise it just doesn't seem all that compelling, especially if the investment options aren't very good.

The compelling things about deferred taxation are:
1) arbitrage - timing withdraws to occur so that they are taxed in a lower bracket in the future than they would be now,
2) growth of deferred taxes - i.e. if I don't pay 20% in taxes, my account has 20% more appreciating assets in it. This is like taking a free loan from the government for years and you get to keep the appreciation.

Of these, #2 seems worthwhile on its own. If the OP defers taxes (let's say 20% bracket) on $100,000 of earnings, for a nice round example, s/he is putting $100k into this non-qualified account instead of $80k into a after-tax account. If that extra 20k earns 5% in each of two years, that's $2,000 in earnings. That may not seem like much, but look at the risks people are taking to get an extra 1% these days!

Regarding tax bracket arbitrage, maybe one could time their FIRE date so they have at least $23.5k earned income in the calendar year they go FIRE. Then, make a 18k contribution to your 401k plus another $5,500 for your traditional IRA, maybe right before quitting. This strategy might further defer part of the tax impact of taking that lump distribution, AND keep the rest of it in a lower bracket. It beats quitting in December and taking your taxable lump sum distribution before end-of-year for sure!