Deferred Compensation & Pension Archives

Siemens Deferred Compensation Elections for Former Employees of Mentor Graphics: 4 Steps to Consider

January 28, 2021 // by adminCordant

Article Summary & Key Points

Employees of what was formerly Mentor Graphics, now Siemens, may find that they are eligible for Siemens’ Deferred Compensation Plan (DCP) and wonder if they should defer their salary and/or bonus into the plan.

In this article, we lay out 4-steps to consider as you evaluate this decision:

Why Defer? The Benefits of Deferred Compensation
The Risks of Deferred Compensation Plans
Go/No Go: Individual Factors to Consider with Deferred Compensation
Three Potential Strategies to Hedge Your Risk

Siemens offers eligible employees a 409(a) Nonqualified Deferred Compensation Plan (DCP) which provides those employees with a fairly straightforward opportunity: willingly forgo income today for a tax benefit. The benefit can be a substantial one, but of course, the benefit comes with a risk. The risk is that the income deferred becomes a liability. In other words, Siemens will need survive long enough into the future such that it can pay its liabilities—pay back the income deferred.

As a participant in any company’s deferred compensation plan, you become an unsecured creditor of your company. You should think about that opportunity as skeptically as a bank underwriter would when approving a loan.

This article will provide a framework to think about the decision to defer and offer potential options for those with money already in the plan to offset some of their risk. This framework is specific to Siemens DCP but can be generalized to any deferred compensation decision.

We’ll start by covering the advantages of deferred compensation (why would you do it in the first place), talk about the risks and how to measure them, look at the individual factors to consider when making your decision, and finally look at potential strategies for offsetting your risk.

Let’s dive in.

The Benefits of Deferred Compensation Plans

Benefits of the Siemens DCP include tax benefits and the benefit of a company match. Overtime, it’s the tax benefits that can have the most material impact so we will review these first.

Tax Benefits

Deferred compensation plans have been around for decades, and regardless of the company offering the plan, the three potential tax benefits remain consistent.

The first benefit is shifting income to years where you are subject to a lower tax rate. Initially, with top marginal tax rates as high as 90 percent in the 1960s and 70 percent in the 1970s, these plans’ primary benefit was this shift. Now, with lower tax rates (the top marginal income tax rate is 37 percent + 2.35% Medicare), tax brackets fairly compressed, and higher executive compensation (meaning potentially large payouts from deferred compensation and other assets in retirement), the contrast in pre- and post-retirement income tax brackets may not be as significant but remains material.

The second benefit is tax deferral: the ability to invest your money pre-tax and have it grow untaxed until the money is paid out.

The longer the tax deferral is in place, the more valuable this is. Deferring taxes one year before retirement and then over a 10-year distribution schedule has value, but deferring taxes for 20 years (allowing your money to grow pre-tax) has a lot more value. Of course, this comes with the risk of your company not being around to make good on its deferred compensation obligations in 10 or 20 years.

Using the assumptions listed in Table 1 below, we can see that deferring income for ten years for an individual at the top marginal tax bracket (37% income tax + 1.45% Medicare + 0.9% Medicare on wages over $200k) and earning a pre-tax return versus an after-tax return results in $22,000 more of wealth even after paying income taxes on your distribution from the deferred compensation plan.

Behold the power of compounded tax-free gains!

Table 1: Tax Calculations – Tax Deferred vs. Taxable

Furthermore, as you can see in the next chart, the longer taxes are deferred, the larger the benefit.

Source: Cordant’s Calculations using assumptions listed in Table 1

The third potential tax benefit is the result of differences in state tax rates. With Federal taxes being low by historical standards, there remains an opportunity for some to defer and potentially avoid state income tax. Consider a resident of Washington State who is employed by Siemens in Oregon. Current residents of Washington state (or future in the case of those who move out of Oregon at retirement) pay Oregon income tax on earnings while employed in Oregon. However, if the DCP’s ten-year or longer payout option is selected, the state tax is based on your state of residence at distribution. So, for many the ability to defer income and avoid the 9% Oregon state income tax by living in Washington state is another big potential benefit of the Siemens DCP. We see benefit most commonly play out for those employed in Oregon or California who move to Washington, Arizona or another state with low or no income tax in retirement.

Siemens Matching Benefit

Not to be overlooked, another benefit of these plans is the company matching benefit, but (as of the time of this posting) there is some confusion around the specifics of how the match is calculated.

The first part of the match is straight forward: the Siemens plan offers to match 6% DCP deferrals (i.e. if you defer $1,000, Siemens matches with a $60 contribution).

The confusion arises here: Siemens also states that it will match “100% of the amount of your deferrals into the DCP up to 6% of your eligible compensation that cannot be taken into account under the 401(k) Plan.” This is especially confusing for former-Mentor employees because their 401(k) plan only matches 50% of their 401(k) contributions up to 3% of salary (most of the other companies under the Siemens umbrella offer a 6% match in the 401(k)). As of the time of this posting, we have been unable to confirm whether Siemens will match 100% of 6% or 100% of 3% of salary not eligible for match in the plan.

Hopefully, this example will highlight the difference. Imagine an employee, age 55, who maxes out their 401k contribution and whose compensation totals $300k (IRS rules dictate that compensation above $290k is not eligible for 401(k) match in 2021). The employee’s contributions and company match will look like this:

401(k) Contributions
- Employee Max Contribution – $26,000 ($19,500 plus the $6,500 allowed by the IRS because the employee over age 50)
- Employer match – $8,700 (3% of the $290k eligible for match in a 401(k))
Deferred Compensation Match
- If the match is truly 100% up to 6% of eligible compensation that cannot be taken into account under the 401(k) Plan, then Siemens would match 100% of the first $9,300 contributed to DCP (6% x $300k – $8,700)
- If, however, the match is up to 3% of eligible compensation then Siemens would match only the first $300 (3% x $300k – $8,700)

We will update this post once we have a confirmed answer.

The Risks of Deferred Compensation Plans

The primary risk of nonqualified deferred compensation plans is that they are, by rule, unsecured liabilities of the company. Your deferred compensation becomes just another liability. You become a creditor of your employer—and lower in priority to any creditor whose loan is secured by the company’s assets.

In addition, when you elect to receive your compensation, that is how long you defer it, is set up front and can’t be changed in most circumstances. Again, this is by IRS rules. You must select your distribution schedule before deferring any income (during your election period), and, except under rare circumstances, you cannot change that. (And typically, if you can change it, you cannot accelerate it. You must elect to receive it even further down the road).

So, you have a situation where you might not see your money until as much as ten years after you retire. For someone younger in their career, this could mean deferring money now, working for another ten years, and then getting the money paid out over the next ten years. In other words, deferring money now and not getting paid back for another 20 years.

So, accessing the financial risk of your company is important, but how to do that?

One way to look at it is simply the average failure rate of publicly traded companies. On average, around 80 public companies file bankruptcy each year. During a recession, this number obviously goes up (136 and 210 filed for bankruptcy protection in 2008 and 2009, respectively) but drops in times of economic expansion (58 and 64 filed in 2018 and 2019, respectively). Taking that 80 companies per year into the 3,700 listed companies here in the U.S. tells us that roughly 2% of public companies file bankruptcy each year.

Of course, not all companies are created equal. Smaller companies should be at higher risk, and Apple isn’t the same risk as J.C. Penny. And of course, even in the case of bankruptcy, some creditors end up recouping a portion of their money.

A more robust way to assess firms’ bankruptcy risk was developed by NYU Professor Edward Altman in the late 1960s, which he called the Altman Z-score. His Z-score uses a blend of publicly available financial statement information (working capital, retained earnings, profit, market value, assets, and liabilities) to predict companies’ bankruptcy risk (at least in the near term).

The higher the score, the better:

The “Safe Zone” is a score of 3 or higher.
The “Grey Zone” is a score between 1.81 and 2.99
The “Distress Zone” is a score of less than 1.81

Currently, Siemens’ Altman z-score is 1.87, which is in the Grey Zone.

Any number in the Grey Zone certainly raises an eyebrow, and with deferred compensation plans, we need to look out many years in the future. Here is where factors specific to you as an individual come into play.

Go/No Go: Three Factors to Consider When Making the Deferred Compensation Decision

In addition to your company’s credit risk and future prospects, several factors specific to your financial situation need to be considered.

Your current exposure to the company: This includes your salary and any stock you own in your company. The more dependent you are on your current salary and the more stock in your employer, the more you will be negatively impacted by poor company performance in addition to your risk in your deferred compensation plan.
How much of your existing net worth is already in the deferred compensation plan? Because the DCP deferral is a new option for many reading this post, this may not apply now, but it could in the future. If a large portion of your net worth is already tied up in deferred compensation, the more risk you have if something goes wrong.
How long do you have until retirement? Again, the longer you have until retirement, and therefore the longer the money will be shielded from taxes, the more significant the potential benefit.

Now, you could certainly imagine a scenario where a company stock, due to slowing growth or other factors, goes nowhere for a decade (think IBM), but the company still remains a viable company. However, it’s less likely (although not impossible: hello, Hertz!) that your company is in financial distress, but the stock price holds steady. For this reason, if you’re worried about your company’s future prospects, selling your company stock may be the right place to start.

However, if you do decide to defer money, you’ll have another three decisions to make:

How much to defer? Siemens allows:
- Up to 50% of Base Salary paid in 2021, regardless of when earned
- Up to 50% of Sales Commissions/Sales Bonus earned in 2021
- Up to 90% of Short-Term/Annual Bonus
When to distribute?
- The year(s) you begin receiving the income you deferred
How to invest?

This is, without a doubt, a lot to factor in. The best way to do this (and what we do for clients) is to have a model that lets us do different scenario analysis to make an informed decision based on both individual factors and your company’s outlook.

Lastly, we will conclude with three strategies to consider for those who may want to offset some of their risk.

Strategies to Offset the Risks in Deferred Compensation Plans

For the majority of those deferring compensation at the majority of public companies, things will work out fine. But for those wishing to take some risk off the table, here are a few options.

Shift Your Risk – Sell Equities

One way to reduce your risk in your employer is to sell the company stock you hold instead of making a change to your DCP. Obviously, if the company is in trouble, the stock price will decline in addition to the credit risk increasing. But you could imagine a scenario where the stock price declines but the company remains solvent. By selling stock and deferring compensation, you transition your risk from equity risk to credit risk and (at least theoretically anyway) higher up in the capital structure.

Here’s how you might combine deferring compensation along with selling your existing shares to lower your risk in the future viability of your employer and still reduce taxes along the way.

Assume you need $120k for living expenses
After income tax (rounded to 40%), that requires a salary/bonus of $200,000 (200,000 * (1-.40) = $120k)
For those holding company stock, another way to generate $120k for living expenses is from selling that company stock.
This exploits the difference in tax rates between income and capital gains.
To generate $120,000 in cash you could sell $157,480 of company stock ($157,480*(1-.238) = $120k). Furthermore, this assumes a $0 basis…any higher basis means less tax and, therefore, fewer shares sold.
This technique does three things:
- Allows you to save $42,000 in taxes in the current year, and
- Allows you to trade equity risk in your company for, theoretically safer, credit risk
- Shifts a concentrated equity position to a more diversified portfolio

This first technique trades one type of company-specific risk for another (and saves taxes along the way). Now let’s look at a couple of options to actually hedge the risk in your employer.

Buying Deep Out-Of-The-Money Puts

Buying a put gives you the right to sell stock at a price set today and therefore profit if the price drops below the strike price. Using puts to hedge your Deferred Compensation plan could be structured as below (please note: actual pricing was not available for Siemens put options on the day of this posting so pricing is just for illustration purposes):

Let’s assume you have deferred $1 million into DCP.
You buy 50,000 January 2023 put options at a $25 strike for $1.00.
If Siemens’ share price declined to $25 between now and January 2023—which it’s assumed it would do if it is in (or on the verge) of bankruptcy—your profit equals $1 million $20 per option times 50k options.
Your cost for this protection equals $50,000 ($1.00 x 50k).
The total cost for this insurance is 5% of the amount hedged or close to 3% per year.

It’s common for listed options only to extend out a couple of years, so with this strategy, you would either need to roll it every other year, or you could potentially work with a trading desk to create a longer-dated, custom option.

This 3% cost per year is obviously not cheap, and many companies will prohibit executives from shorting their company stock (which buying a put is typically considered since you profit if the price of the company stock falls).

Due to these restrictions and the cost, let’s look at one more option.

Deferred Compensation Protection Trust

A more recent entrant into this space is the Deferred Compensation Protection Trust. Developed by a company called StockShield, this trust essentially pools your risk with others across various companies and industries. An example of how this works according to their website:

Twenty (20) participants, each with a certain minimum balance in an NQDC [Non-Qualified Deferred Compensation] plan sponsored by a different company in a different industry, deposit a small amount of cash (e.g., 1%) for each year of desired protection (minimum 5 years). The pooled cash is invested in U.S. Treasury Securities. At the end of the term of the trust, the assets pooled in the Trust are paid according to the number of bankruptcies.

Assuming your company files bankruptcy in the period covered, the pooled funds would be used to offset your loss. If no companies in the pool file bankruptcy, the funds are returned minus trust expenses.

1% per year for protection isn’t too bad of a deal, although you run the risk of your losses not being fully offset in the case of multiple bankruptcies.

Conclusion

There is certainly a lot to factor in when it comes to your deferred compensation decision each year. If you pass on participating, you’re potentially leaving a valuable tax benefit on the table, but if you do contribute, you increase the financial risk tied to your employer.

Hopefully, this article has been helpful, but if you’re still struggling to assess this trade-off and make a decision that tips the odds in your favor, get in touch. We’d be happy to talk about how we can build a financial decision-making model for you to run scenarios on these and any significant financial decisions you’re considering.

The Intel Pension Plan: Understanding the Major Change in 2021 and How to Assess Your Retirement Decision

December 11, 2020 // by adminCordant

UPDATE: We are aware that Intel has changed course and will NOT be changing its minimum pension calculation. We will update this blog post as more information is available.

Today we are going to tell you everything you need to know about the upcoming 2021 changes to the Intel Minimum Pension Plan (MPP). We are also sharing free resources and templates to help you take quick action.

For those employees eligible for Intel’s minimum pension benefit (MPP) at retirement, the interest rate used to calculate today’s value of that benefit is changing. This means that your estimated Minimum Pension Plan benefit amount is significantly reduced or erased altogether in many cases. There now exists a meaningful incentive for many long-time Intel employees to retire from Intel before May 2021.

We’ve received many questions so far about the relevance and magnitude of these changes on one’s retirement plans. And to paraphrase a famous line from Seinfeld, “The changes are real, and they’re significant.”

The most common questions we’ve received are:

Is the change real? Yes, from what we’ve seen, this change makes a meaningful difference (six-figures) for many Intel employees.
Is Intel doing this? No, the change is being driven by a policy change with the Pension Benefit Guaranty Corporation (PBGC), which insures Intel and other pension plans.
What should I do next? Assess the magnitude of the change for you personally and evaluate if it makes sense to move your retirement date to before May 3rd, 2021.

In this post, I will review how the Intel Minimum Pension works, what is changing, and what actions you should take if you are affected by the change.

Free Resources:

Intel Years of Service and Benefits [Excel download]

Pension: Lump Sum vs. Monthly Income [Excel download]

Pension: Lump Sum vs. Monthly Income [Flowchart; pdf download]

What Issues Should I Consider Before I Retire? [Checklist; pdf download]

Additionally, we are offering a Free Intel Retirement Timing Assessment. This includes an initial conversation, analysis of the value of your benefits, review of your pension decision and retirement action plan should you decide to leave Intel.

How the Intel Minimum Pension Works

Intel’s pension plan is a minimum benefit pension plan. That means Intel calculates a minimum benefit for eligible employees in retirement and then compares that to the balance in your Retirement Contribution Account (or, more precisely, the monthly annuity income produced by your “RC Account”).

We have previously written in more detail about how your pension benefit is calculated, but the key factors are your years of service and final average pay.

Final Average Pay: Your average pay during the highest-earning years. Your estimated social security benefits are also used in the calculation—meant to provide a retirement benefit on the earnings not factored into your social security benefits.
Years of Service: Income above is multiplied by your years of service to determine your pension benefit.

That’s the calculation for your Pension Benefit.

The purpose of the minimum pension plan is to guarantee a minimum level of income in retirement in addition to the balance/benefit of your Retirement Contribution Account (“RC account”). When your Pension Benefit is calculated, Intel ensures that the RC Account is valuable enough to provide that benefit. They do this by using the Minimum Pension Plan (“MPP”) as a gap fill.

It works like this: The present value of the calculated minimum benefit is compared to the value of the RC Account (remember this is the account into which Intel used to make matching 401(k) contributions). This calculation is done using an annuity factor, which is what is changing in 2021.

If the RC Account is greater than the present value of the calculated minimum benefit, there is no MPP.
If the present value of the minimum benefit is greater than the RC Account, then the MPP provides a benefit in the form of an annuity or a lump-sum distribution to make up for the shortfall (for more on evaluating whether to elect a lump sum or annuity payment see this post on What to do with Your Intel Pension when you Retire)

The point I want to stress here is that the MPP only exists to the extent that the RC Account is calculated to be short of providing the intended minimum benefit.

What is Changing With Intel’s Minimum Pension Plan

Again, the annuity factor used to calculate the present value of the minimum pension is changing. This is not a change driven by Intel, but a policy change by the Pension Benefit Guaranty Corporation (PBGC) “intended to modernize the methodology” used for its present value calculations. The PBGC, a government agency, has changed the rates used for this calculation as follows:

Currently, the interest rate used is 0%
As of May 5^th 2021, the rates used will be in 3 time-based tiers of 0.51%, 2.31%, and 3.15% (to simplify, Fidelity has suggested using ~2.5% as the rate to think about this)

You should note: The PBGC is actually making these rates effective January 1^st of 2021, but Intel is extending the use of the old rate until May 5^th to allow employees to plan accordingly.

The increase from 0% to 2.5% is material because it significantly reduces the present value of the future benefit.

To illustrate the magnitude, consider the example of an employee with a $375k RC Account (note: I am using simple numbers and annual as opposed to monthly annuity payments to simplify the calculation):

Example 1: Let’s say Intel calculated that based on the employee’s years of service and average pay, she is entitled to a benefit of $20k/year paid annually for the next 25 years. Assuming 0% interest, the present value of that annuity is $500k
- Today, she would retire with her $375k RC Account AND her MPP in the form of a lump-sum distribution or annuity to make up for the $125k shortfall.
Example 2: If, however, we assume an interest rate of 2.5%. The present value of the same 25-year $20k/year annuity is only $368,488.
- Thus, in this case, she receives NO MPP benefit because the $375k RC Account value is sufficient to provide the minimum benefit.

In the second example, the rate-increase completely wiped out her MPP! For this employee, there would be a $125k incentive to retire and take her pension prior to the rate change.

We’ve seen examples of a $100k, $200k, and nearly a $300k incentive for retiring before May of 2021, which bring us to our last section: how to go about making this decision in the next few months.

Assessing Your Suddenly Urgent Retirement Decision: What should you do?

Understand how the change impacts you:

To first wrap your arms around the magnitude of this decision, login to Fidelity’s netbenefits website, and view how your MPP is impacted by the change. When you log in, you will see this banner across the top, and you can click “view now” to see how the change affects your benefit:

You will get a report this looks like the one below and will bottom line your incentive to retire before this interest rate goes into effect.

Again, we’ve seen estimates range from as little as $100k to almost $300k.

Be aware of key dates

To take advantage of your pension benefit prior to the PBGC interest rate change, you must leave Intel by May 3rd, 2021. Other key dates to be aware of are dates for bonus payout and vesting for RSUs, PSUs, and OSUs.

Determine whether this change should affect your retirement timeline

If you were planning to retire within the next couple of years, this change might provide an incentive to retire sooner. What is the best time to retire from Intel? You will want to compare the change in MPP with the incentives of continuing to work. Some of the issues to consider are:

Cash Flow Issues
- Income, Expense, and Tax Planning
- How much in spending will your assets safely support? “Will I run out of money if I stop working?”
- Will you take Social Security? What’s your claiming strategy?
- Payout and timing of Salary, Bonus, and accelerated vesting of RSUs and other equity compensation
- Pension payout in a Lump Sum or monthly income
- Income sources (SSI, Pension, Earned Income) and how much is needed from your portfolio
- What accounts will your money be drawn from in order to minimize taxes?
Health Care and Insurance Issues
- Are you aged 65 and eligible for Medicare?
- If not, will you fill the gap with Private insurance or COBRA and the cost of each?
- How much do I have in my SERMA account?
- Have your needs for Life Insurance changed? Will you lose coverage?
- Are you concerned about funding Long-Term care?
Intel Benefits Issues
- Are you, or will you reach, Rule of 60 or Rule of 75?
- Timing of Salary and Bonus Payouts
- SERPLUS Deferral and Staring date of payout
- Timing and potential acceleration of RSUs, OSU, PSU, and Option grants

This list is a start but by no means meant to be comprehensive. For more, see our checklist: What Issues Should I Consider Before I Retire?

We’re here to help if you need us

If you’re like most Intel employees we’ve talked to, it’s quite the shock to suddenly face a decision to retire (more fun in 2020!). And given the short timeline (you must make a decision by early May) and the magnitude of the decision (a six-figure decision for many), this is a stressful period.

There is a lot to think about before making a decision in response to this change: tax ramifications, cash-flow planning, health care planning, etc., as we outlined above.

We specialize in helping our clients make smart financial decisions when faced with changes like this, and we would be happy to discuss how this impacts your individual situation.

Given our long-time history of working with Intel employees, we are offering a Free Intel Retirement Timing Assessment. Through a conversation, analysis, and a review together, we’ll show you how to optimize the date you leave intel. We’ll share our perspective on:

Your Pension Decision
An Assessment on the value of your Intel benefits and stock if you leave BEFORE or AFTER May 2021
A Retirement Action plan if you do decide to leave.

This should help you to evaluate the value of our services and make an informed decision about hiring our firm. And if you simply want to take the assessment and execute on your own, that’s fine too.

To schedule your assessment, start here: cordantwealth.com/start-here

SERPLUS or Mega Roth? Prioritizing Two of Intel’s Tax-Preferenced Savings Opportunities

December 3, 2020 // by adminCordant

Ideally, with each paycheck or bonus paid we would have all the cash flow we need to support regular cash-flow needs, achieve our larger financial objectives and optimize deferrals to tax-advantaged accounts and other tax savings opportunities. However, money is a resource, and like most resources it’s limited. We are forced to prioritize where we spend, the objectives we further, and the extent to which we utilize tax-saving opportunities.

Because many employees prioritize maxing pre-tax contributions to their 401(k)s and HSAs (as I think they should in most cases), we are often asked what to prioritize once those contributions are maxed out. Specifically, employees who are eligible to defer to Intel’s deferred compensation account (“SERPLUS”) ask:

Should I make after-tax contributions to my 401(k) (a.k.a., mega Roth contributions) OR should I contribute to SERPLUS?

The final decision depends on the individual employee’s situation so let’s look at the benefits and risks of each to inform the decision and then review what an individual should consider in assessing the decision for themselves.

Benefits and Risks of SERPLUS

We recently detailed 4-Steps to consider when you evaluate the decision to defer to SERPLUS in any capacity, but for the purpose of this post let’s look at the benefits and risks at a high level.

Employees who are eligible to contribute to Intel’s deferred compensation account, SERPLUS, are given the opportunity to forgo income today in order to reap both current and future tax-benefits.

The immediate tax benefit is that you reduce income in the year you defer thus paying less in tax for that year.
The future benefit is two-fold: 1) funds in the SERPLUS account can be invested and are allowed to grow tax-deferred until distributed, and 2) when those funds are distributed there is a high probability the employee will be in a lower tax bracket then they are in currently.

Of course, these benefits come with some risks, the largest of which is that when you defer to SERPLUS you become an unsecured creditor of Intel. In other words, Intel has to survive and be able to pay its debts in order for you to eventually receive the income you deferred.

In other words, with SERPLUS, you get a potentially significant dual tax-benefit that comes with a risk tied to the future of Intel.

Benefits and Risks of Mega Roth Contributions

For a detailed look at the benefits of after-tax contributions and how to take advantage and optimize them, I encourage you to read this post on Understanding Intel’s New Mega Roth 401(k).

Last year (2019), was the first year an Intel employee could make what is called a Mega Roth Contribution. This is an after-tax contribution to a 401(k) which is then immediately converted to Roth. We were thrilled that this new opportunity for additional tax-preferenced savings was made available to our Intel-employed clients because it allows them to take two advantageous actions:

Maximize the amount of 401(k) savings beyond pre-tax limitations with after-tax contributions up to the IRS limits; and
Convert those after-tax contributions to Roth where they can be invested and grow tax-free

The benefit of a mega-Roth contribution is the tax-free growth of the investments in the account. Since many employees who are eligible for SERPLUS are otherwise unable to contribute to Roth IRAs because their income exceeds IRS thresholds or because “Backdoor Roth” contributions are unavailable to them, this offers an opportunity for tax-free investment growth that wouldn’t otherwise be available.

The main risk is legislative. And while that could be said for any 401(k) or other retirement account contribution, I see it as a greater risk here because there have already been two congressional proposals in recent years (neither enacted) to limit or remove the ability to convert after-tax 401(k) contributions to Roth. While a real risk, keep in mind that if congress enacted a change, contributions would still be in a 401(k) and allowed to grow tax-deferred. Tax-deferred growth is not as nice as tax-free growth, but the benefit is still material and I see this risk as minimal compared to that of SERPLUS.

SERPLUS or Mega ROTH: Factors to consider

As I said in the beginning, whether a contribution to SERPLUS or Mega Roth is best for you will depend on your individual situation. In many cases, the dual tax benefits of SERPLUS (even with the risks) outweigh the benefit of the tax-free growth that comes with Mega Roth contributions, but that is not always the case. Here is what we consider when we look at this decision with our clients.

Current tax bracket – How much of a benefit is reducing income in the coming year with a deferral to SERPLUS. Keep in mind, this benefit could be much greater in years where income is higher. For example, you or your spouse expect a large bonus, increased capital gains, or one of you is retiring in the coming year and there will be other benefits paid out—any of these would make a SERPLUS deferral more attractive.
Expected future tax Bracket – How much tax does the client expect to pay when the SERPLUS funds are distributed. If the client expects to be truly retired and have no or very little income, the benefit of paying income tax in those years as opposed to paying at current income tax rates could be huge. We often see clients go from the 35% federal marginal tax bracket while employed to the 10% marginal bracket when retired. If you deferred $50,000 dollars to SERPLUS, that could be a difference of $12,500 in federal taxes owed on that income!
Expected time for Growth –SERPLUS will be limited to the elected period of deferral, but a Mega Roth contribution could have an extremely long time horizon for growth. For example, if an estate objective is a client’s priority, the ability to get funds into a Roth account where the funds could be invested and grow tax-free and untouched for the client’s life could greatly increase the likelihood of achieving the estate objective.
Magnitude of the Risk – As stated above, the more acute risk is with SERPLUS – the magnitude of which is all about how much the client already depends on the future of Intel. With our clients we ask:
- Would they have opportunities at other companies if Intel didn’t survive?
- If married, do both spouses work for Intel?
- How much do they already have deferred into SERPLUS?
- How much company stock do they hold?

If you are making this decision for yourself, I hope my outlining the benefits, the risks and the factors to consider helps inform your decision. If you would like help analyzing your situation specifically so that you can make the decision that is best for you, please feel free to reach out. I’m happy to take some time to discuss how this or any other deferral decision could impact your situation.

Intel SERPLUS Elections 2020: 4 Steps to Consider Given the Recent Company Uncertainty

November 20, 2020 // by adminCordant

A clever person once said it’s “difficult to make predictions, especially about the future.” This is true with most things, and it’s undoubtedly true with investing. However, despite the unpredictability of the future, there comes a time when we must place our bets and choose a direction—Ideally, one that tips the odds in our favor.

409(a) Nonqualified Deferred Compensation Plans present one of these opportunities. You willingly forgo income today with the faith that your company will survive many years into the future to make good on this liability to you—all for a tax benefit that tips the odds in your favor.

As a participant in your company’s deferred compensation plan, you’ve become an unsecured creditor of your company. You should think about that opportunity as skeptically as a bank underwriter would when approving a loan. As Andy Grove once said, “only the paranoid survive.”

There are always unknowns when it comes to the future of any investment, but to make matters worse for Intel employees, at yet another inflection point in the company’s history, the uncertainty has taken center stage.

Competition closing in, manufacturing delays, and considering, for the first time ever, outsourcing the manufacture of some of its most advanced chips. The stock market has noticed these challenges, with Intel shares down 22% year to date compared to up 10% for the market overall and up 30% for the Technology sector.

All these “unknowns” and Intel’s recent stock market performance cause many participants in Intel’s Deferred Compensation program (SERPLUS) to wonder—should I not defer money this year or change my deferral strategy?

This article will provide a framework to think about this decision and offer potential options for those with money already in the plan to offset some of their risk. This framework is specific to the Intel SERPLUS fund but can be generalized to any deferred compensation decision.

We’ll start but covering the advantages of deferred compensation (why would you do it in the first place), talk about the risks and how to measure them, look at the individual factors to consider when making your decision, and finally look at potential strategies for offsetting your risk.

Let’s dive in.

The Benefits of Deferred Compensation Plans

Deferred compensation plans have been around for decades, promising two potential benefits. Initially, with top marginal tax rates as high as 90 percent in the 1960s and 70 percent in the 1970s, these plans’ primary benefit was to shift income into lower-tax, retirement years. Now, with lower tax rates (the top marginal income tax rate is 37 percent + 2.35% Medicare), tax brackets fairly compressed, and higher executive compensation (meaning potentially large payouts from deferred compensation and other assets in retirement), most tax analysis is done at the top marginal tax bracket both pre and post-retirement (except for state income tax planning which we will address in a bit).

Today, these plans’ main benefit is the tax deferral feature—the ability to invest your money pre-tax and have it grow untaxed until the money is paid out.

Behold the power of compounded tax-free gains!

Table 1: Tax Calculations – Tax Deferred vs. Taxable

Furthermore, as you can see in the next chart, the longer taxes are deferred, the larger the benefit.

Source: Cordant’s Calculations using assumptions listed in Table 1

Not to be overlooked, another benefit of these plans is any company matching benefit. In 2020, for example, the Intel plan offered to match SERPLUS deferrals up to 5% of “excess pay” (pay above $285k in 2020). So, if your salary and bonus totaled $385k ($100k excess pay), you would want to defer at least $5k to get the full match (5% of $100k).

[See our full article on Intel’s SERPLUS match and the changes put in place for 2020, here.]

Lastly, as we alluded to before, even with Federal taxes being low by historical standards, there remains an opportunity for some to defer and potentially avoid state income tax. Current residents of Washington state (or future in the case of those who move out of Oregon at retirement) pay Oregon income tax on earnings while employed in Oregon. However, if the SERPLUS ten-year payout option is selected, the state tax is based on your state of residence at distribution. So, for many the ability to defer income and avoid the 9% Oregon state income tax by living in Washington state is another big potential benefit of the Intel Deferred Compensation plan.

The Risks of Deferred Compensation Plans

So, accessing the financial risk of your company is important, but how to do that?

The higher the score, the better:

The “Safe Zone” is a score of 3 or higher.
The “Grey Zone” is a score between 1.81 and 2.99
The “Distress Zone” is a score of less than 1.81

Currently, Intel’s Altman z-score is 3.59, in the safe zone but has been trending down for the last decade and lower than competitors AMD and NVIDIA. (See chart below)

It appears Intel is safe in the short term, but obviously, with deferred compensation plans, we need to look out many years in the future. Here is where factors specific to you as an individual come into play.

Go/No Go: Three Factors to Consider When Making the Deferred Compensation Decision

In addition to your company’s credit risk and future prospects, several factors specific to your financial situation need to be considered.

Your current exposure to the company: This includes your salary and any stock you own in your company. The more dependent you are on your current salary and the more stock in your employer, the more you will be negatively impacted by poor company performance in addition to your risk in your deferred compensation plan.
How much of your existing net worth is already in the deferred compensation plan? If a large portion of your net worth is already tied up in deferred compensation, the more risk you have if something goes wrong.
How long do you have until retirement? Again, the longer you have until retirement, and therefore the longer the money will be shielded from taxes, the more significant the potential benefit.

However, if you do decide to defer money, you’ll have another three decisions to make:

How much to defer?
When to distribute?
How to invest?

These final three decisions we cover more in-depth here: The Four Factors to Consider When Making Your SERPLUS Elections

Lastly, we will conclude with three strategies to consider for those who may want to offset some of their risk.

Strategies to Offset the Risks in Deferred Compensation Plans

For the majority of those deferring compensation at the majority of public companies, things will work out fine. But for those wishing to take some risk off the table, here are a few options.