Deferred Compensation vs Roth 401k

[ggmorning]

Hi everyone. I know there are plenty of posts on 401k's but I couldn't find much as far as comparing it to deferred compensation. My current job matches my contributions up to 7% with both deferred compensation and roth 401k options. I am not the best with understanding these options, but with my research I have learned:

Deferred Compensation: the funds taken out reduce the taxable income of my pay, but I must pay taxes on these funds when I do take them out in the future. Also I am not 100% sure if this is correct, but these funds can not be borrowed against?

Roth 401k: is taxed now, every pay check, but the amount I see in the 401k account is the amount I will actually receive when I do retire and decide to take the funds out. Funds can be borrowed against if need be (with fees?).

What is better for an average person who is just trying to save to supplement retirement? I know it depends on the person and probably can't br answered for me - but I am just curious to see other's opinions and which the yfavor and why. I think I am more confused about deferred compensation -- taxes can't be the same now as when they are 35-40 years from now, right? Is choosing deferred comp. a bigger risk? Or am I completely mistaken? Thanks in advance!

[bada_bing]

The difference depends on what your tax rate is now, verses what it will be when you draw the money out. Guessing what your rate will be involves some uncertainty. Most people are better off taking the deduction up front and  paying the taxes later at a (hopefully) lower rate. 

I'm curious about the deferred compensation plan. It is unusual to be offered a Roth 401K but not be offered a regular (deductable) 401K as an option. The employer matching fund have to go into a tax deferred regular 401K account and I don't think I've ever seen a 401K plan that didn't have a regular tax deductible account as an option for employee savings contributions.

Likewise, a deferred compensation package is usually in addition to a 401K, not in lieu of one. Deferred compensation is a way for highly paid employees to sock away more savings after they have filled up the annual limit in 401K contributions.

[Anonymous]

One advantage of the Roth is that there are no RMDs after you turn 70 (Required Minimum Distributions).  That's where you are forced to withdraw a percentage of your tax-sheltered money each year.

This can be an advantage if you think you might wish to spend less (and therefore withdraw less) in order to protect yourself against the possibility of a long life (e.g. needing money in your late 80s or 90s).

My (retired) father's spending is significantly less than the amount of his RMD, so he is forced to withdraw money he doesn't want to, pay tax on it, and then reinvest it in a taxable account.

One very high-level recommendation that applies to lots of investment for retirement is diversity.  E.g. don't have just stocks, but have stocks and bonds.  Within stocks, don't have just domestic, but have domestic and foreign.  Within domestic, don't just have the S&P 500, but have small-cap as well. 

Similarly that might apply to this question as well.  E.g. if you decide to go the conventional route, still place 4-5 k each year into a Roth IRA.  That way you'll have a tax-free pot of money that is protected from RMDs.

[DaveInAZ]

Yes, it is very unusual for an employer to offer a Roth IRA, normally it is a Traditional, tax deferred, IRA. And tax deferred is better for most people as most people are at  much lower tax rate in retirement, Social Security payments are usually non-taxable, they are only taxable income if you have high other income.

But actually deferred compensation package is usually in lieu of a 401K, not in addition to one. That's because highly compensated employees are not allowed to contribute to a company 401k plan by IRS regulations. My previous employer offered a Traditional 401k and had a deferred compensation plan for the less than 10 employees who were too highly compensated to participate in the 401k, 10 employees out of around 1000.

And no, I'm pretty sure you can't borrow against a deferred compensation plan.

[MakingProgress]

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@DaveInAZ wrote:

Yes, it is very unusual for an employer to offer a Roth IRA, normally it is a Traditional, tax deferred, IRA. And tax deferred is better for most people as most people are at  much lower tax rate in retirement, Social Security payments are usually non-taxable, they are only taxable income if you have high other income.

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My employer offers both a Roth 401K and a Traditional 401K.   I contribute to both 5% of my income to the Roth and 8% to the Traditional.   My employer matches 100% of my 1st 6%.   All employer contributions are tax deferred.   So even if I was only contrubuting to the Roth the employer contributions would be in a tax defered status until I withdraw them.

Then my employer also offers what is called a Retirement Accumulation Plan.   This is 100% funded by the company at 3% of my annual income.  Therefore between this plan and my 401K I am getting 9% of my income each year put away for retirement in addition to what I am saving.   

[iced]

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@ggmorning wrote:

Hi everyone. I know there are plenty of posts on 401k's but I couldn't find much as far as comparing it to deferred compensation. My current job matches my contributions up to 7% with both deferred compensation and roth 401k options. I am not the best with understanding these options, but with my research I have learned:

Deferred Compensation: the funds taken out reduce the taxable income of my pay, but I must pay taxes on these funds when I do take them out in the future. Also I am not 100% sure if this is correct, but these funds can not be borrowed against?

Roth 401k: is taxed now, every pay check, but the amount I see in the 401k account is the amount I will actually receive when I do retire and decide to take the funds out. Funds can be borrowed against if need be (with fees?).

What is better for an average person who is just trying to save to supplement retirement? I know it depends on the person and probably can't br answered for me - but I am just curious to see other's opinions and which the yfavor and why. I think I am more confused about deferred compensation -- taxes can't be the same now as when they are 35-40 years from now, right? Is choosing deferred comp. a bigger risk? Or am I completely mistaken? Thanks in advance!

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Which way will ultimately work out better for you entirely depends on your retirement strategy. If you are aiming for retirement income (forget capital gains for now, just taxable income from SS/401k/etc) to be lower than what your current taxable income is, deferred compensation/traditional 401k is the better option. If you are aiming for higher retirement income than current, Roth may make more sense. It's impossible to know exactly which will be better since we don't know what the tax system will look like when you retire, but if things stay generally the same, that's what you can expect.

The takeaway here is that there is no one-size-fits-all answer that makes this easy. You need to sit down and plan out your retirement goals, estimate what they will cost, and determine your sources of income. Without this, we're just spitballing as to which will be better for you.

As for me personally, I'm shifting more heavily toward Roth sources for IRA/401k contributions. Every year I cap 401k and IRA contributions, but I've shifted from about 70/30 Traditional/Roth to 50/50 annually and will continue to slide toward a 30/70. I'm doing this for two reasons:

1. I was making less in the past and was able to suppress my AGI enough with 401k and other deductions to still qualify for Roth IRA. Now, even if I contribute the full $18k/year into traditional 401k I cannot suppress my AGI enough to qualify for Roth, so I might as well shift toward Roth 401k and do an IRA rollover into Roth each year.

2. I'm looking to be very heavy in the capital gains department in retirement. My retirement plan is to have a little under $300,000 per year in income, with about 2/3rd of that coming from capital gains sources (equity sales and dividends). This means I want to suppress my non-capital-gains AGI as much as possible to stay in a low income bracket. By only taking RMD from 401k and the rest from Roth, I will try keep my taxable AGI under ~$70,000/year (12% bracket) with capital gains covering the rest. This has the added bonus of allowing some of my capital gains to be taxed at the lowest bracket (0%) with the rest only at 15%. This strategy means I need to go as heavy toward Roth as possible, as then my only taxable income would be traditional 401k/403b plans (and Social Security, if it's even solvent in 30 years).