Author Topic: Nonqualified deferred comp  (Read 219 times)

leftcoaster

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Nonqualified deferred comp
« on: October 30, 2018, 08:35:47 AM »
I have access to a non qualified deferred compensation plan at work.  I can defer up to 50% of my salary.

Company is stable and not likely to be acquired.  I am aware of the risks of a non-qualified plan.

My salary is just over the maximum compensation threshold for employer matching in the qualified 401(k) plan.  So, if I do NOT defer, I get the maximum employer match.  If I do defer to the full extent, I forego about $8K of free deferred money.

I also have an after tax 401(k) plan which I can convert immediately to a Roth (mega backdoor).  If I do not defer, I can get a full $20K into this plan.  If I do defer to the full extent, I can only get $14K into the plan.

So, why defer?  Even if I defer to the full extent, I will still be in the top federal/state brackets for California.  So, the amount I would potentially defer would otherwise be taxed at an effective rate of 49.3%. 

However, if I defer that amount every year for the next 6 years and then take FIRE payments over 10 years, my effective rate drops to 15.4%.   I avoid $56K in tax on each year's deferred contribution.

Is this the no-brainer that I think it is?

MDM

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Re: Nonqualified deferred comp
« Reply #1 on: October 30, 2018, 01:50:52 PM »
However, if I defer that amount every year for the next 6 years and then take FIRE payments over 10 years, my effective rate drops to 15.4%.   I avoid $56K in tax on each year's deferred contribution.

Is this the no-brainer that I think it is?
Possibly, although unless you have to make an irrevocable decision now that applies to all six years to come, the effective rate is not the one to use.  E.g., see Marginal Vs Effective Tax Rates And When To Use Each.

The first year of deferral probably is the no-brainer, and all of them may be.  But, for example, once you have contributed for five years, what is the marginal withdrawal tax rate on the extra amount you can withdraw if you defer a sixth year?

reeshau

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Re: Nonqualified deferred comp
« Reply #2 on: October 30, 2018, 01:54:58 PM »
Also, make sure the plan is insured against company insolvency.  If it is "self insured," which is common for large companies, then you become an unsecured creditor in case of bankruptcy and it likely goes bye bye.

leftcoaster

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Re: Nonqualified deferred comp
« Reply #3 on: October 31, 2018, 08:21:47 AM »
However, if I defer that amount every year for the next 6 years and then take FIRE payments over 10 years, my effective rate drops to 15.4%.   I avoid $56K in tax on each year's deferred contribution.

Is this the no-brainer that I think it is?
Possibly, although unless you have to make an irrevocable decision now that applies to all six years to come, the effective rate is not the one to use.  E.g., see Marginal Vs Effective Tax Rates And When To Use Each.

The first year of deferral probably is the no-brainer, and all of them may be.  But, for example, once you have contributed for five years, what is the marginal withdrawal tax rate on the extra amount you can withdraw if you defer a sixth year?

I see that I use the wrong term (thanks for that Kitces article).  15.4% is the total tax I would pay according to current tax tables not the effective rate defined there.  I would still have plenty of "room" in the same brackets before stepping up to the next one and I'd be nowhere near the brackets I'm currently in.

leftcoaster

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Re: Nonqualified deferred comp
« Reply #4 on: October 31, 2018, 08:22:44 AM »
Also, make sure the plan is insured against company insolvency.  If it is "self insured," which is common for large companies, then you become an unsecured creditor in case of bankruptcy and it likely goes bye bye.

Yes, I addressed that when I said that I'm aware of the risks.  I consider the risk acceptable in my case. 

MDM

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Re: Nonqualified deferred comp
« Reply #5 on: October 31, 2018, 08:56:48 AM »
15.4% is the total tax I would pay according to current tax tables not the effective rate defined there.
By "total" do you mean 12% federal plus 3.4% state marginal rates?  Otherwise, "total" and "effective" are usually used synonymously in this context, so...?

Quote
I would still have plenty of "room" in the same brackets before stepping up to the next one and I'd be nowhere near the brackets I'm currently in.
In that case, yes it's a good idea.

leftcoaster

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Re: Nonqualified deferred comp
« Reply #6 on: October 31, 2018, 12:29:08 PM »
15.4% is the total tax I would pay according to current tax tables not the effective rate defined there.
By "total" do you mean 12% federal plus 3.4% state marginal rates?  Otherwise, "total" and "effective" are usually used synonymously in this context, so...?

Quote
I would still have plenty of "room" in the same brackets before stepping up to the next one and I'd be nowhere near the brackets I'm currently in.
In that case, yes it's a good idea.

Yes, 12 + 3.4.  Thanks for the feedback!