It is time to decide on your 3M Deferred Compensation. This may be the first time you are eligible to participate or you may have been making this decision for years. If you are not eligible yet, you might be in a few years. Regardless of your situation, it is important to make an informed choice. We think this blog will help.
The purpose of both of 3M’s non-qualified1 deferred compensation plans - VIP Excess and Deferred Compensation Excess - is to provide savings opportunities for employees that have planned cash compensation2 in excess of the qualified3 plan limits. The plans are used to attract and incentivize highly compensated 3M employees.
Employees with planned cash compensation in excess of $290,000 are eligible for either plan. Planned compensation includes income earned during the year, even if paid in the subsequent year. For instance, if your planned cash compensation for 2021 is $350,000, comprised of $270,000 base salary and $80,000 variable pay, and your bonus of $80,000 is paid in March 2022, the bonus is considered planned compensation for 2021.
To be eligible to participate in either plan, you need to be employed by 3M. For the VIP Excess plan, you also need to be eligible to contribute to VIP. For the Deferred Compensation Excess plan, you also need to be eligible to receive sales commissions, management objective or annual incentive plan (AIP) income.
Eligibility for both plans is based on whether your planned cash compensation exceeds the qualified plan limit compensation as of November 1st of the immediately preceding year and will be re-evaluated each year.
3M offers two plans that have many different characteristics to compare and contrast.
VIP Excess allows whole percentage contributions between 2% and 10%. You need to elect the same contribution percentage to VIP and VIP Excess. For instance, if you elect 7% to your VIP Excess, you must also elect 7% to VIP.
The VIP Excess contribution begins at the earlier of when you meet the maximum VIP deferral for the year, $19,500 for 2021, or when you reach $290,000 in compensation. If you elect to participate, both your VIP and VIP Excess contribution percentages are irrevocable for the year.
The Deferred Compensation Excess plan allows whole percentage contributions of up to 50% of base salary and up to 90% of variable pay. The contributions will not begin until income exceeds $290,000.
3M provides a match on VIP Excess contributions in the same matching percentage you receive on your 3M VIP. The matching percentage is determined by what Portfolio you are eligible for. Additionally, Portfolio III employees are eligible for a 3% non-elective contribution.
3M does not provide any contributions or matching to the Deferred Compensation Excess plan.
Both VIP Excess and Deferred Compensation Excess have the same investment options. If you participate in the 3M VIP plan, the investment choices are going to look familiar to you. All the funds available in the 3M VIP plan are available except the 3M stock fund and PCRA4 option. Additionally, both plans offer a stable value fund that is not available in the VIP Plan.
Because this is a non-qualified plan, the funds are not actually invested. Instead, your plan balances are adjusted to reflect performance as if the funds were invested.
There are many factors to consider when determining whether you should participate in 3M’s deferred compensation plans.
The tax implications are the same for each plan.
Federal income taxes are deferred on your contribution amount and on the ongoing earnings in the funds you have chosen. While state tax rules may vary, Minnesota also allows deferral of taxes.
FICA5 taxes are owed at the time of deferral. Future earnings are not subject to FICA taxes and will not be payable when amounts are eventually distributed.
At payout, distributions and earnings are subject to ordinary income tax rates. Unless you have supplemental wage income in excess of $1M, 22% federal withholding and 6.25% Minnesota withholding are the applicable withholding rates (or state of residence rate). When receiving distributions, you may need to pay in extra or adjust other withholdings to ensure enough tax is paid in.
There is an opportunity to shift income to a different state if you plan to move in retirement6. 3M’s deferred compensation benefits will be taxed in your state of residence at the time they are received. For instance, if you earned the money while in Minnesota and plan to be a Florida resident in retirement, you could save a significant amount in state income taxes.
In order for a non-qualified plan to receive tax deferral, no separate trust fund or assets can be set aside. Therefore, by contributing to these plans you become an unsecured creditor of 3M. This differs from your VIP Plan where you have a separate account that is owned by you and secured from creditors of 3M. These plans are also unfunded, which means 3M’s ability to pay your accrued benefit depends upon its current and future financial health.
There is no impact on your total pension benefit by contributing to either plan. The Deferred Compensation Excess plan does not allow any contributions until cash compensation exceeds the qualified plan limit compensation.
The VIP Excess could reduce income eligible for the qualified pension benefit, depending upon the percentage elected. However, 3M’s non-qualified pension plan will pay a pension benefit equal to the amount your qualified pension was reduced.
Each year that you participate, you also need to elect a payout option. Payout options do not need to be the same as prior elections and can change from year to year. However, once you select a payout option for the year, it is irrevocable.
You need to elect both the timing of your distribution and the form of the distribution. The payments can begin one to ten years post retirement7. You can either receive payments as a lump sum or series of annual payments between two and ten annual payments.
You will receive your first payout based on your election and date of retirement, either January or July after you have been retired at least 6 months.
You are not allowed to roll your VIP Excess or Deferred Compensation Excess plan balances into an IRA or any other tax-qualified plan. The amounts will instead be paid out based on the yearly elections you have made.
If you leave 3M before retirement, which is defined as before Age 55 and 5 years of service, you will receive a single lump sum in either January or July, depending upon date of separation.
If you die before your payments begin, a lump sum payment will be made to your beneficiary in January of July of the following year, depending on date of death.
If you die after your payments begin, the remaining balance will be paid to your beneficiary on the same schedule as you were receiving payments.
Your beneficiaries must be the same for VIP Excess and Deferred Compensation Excess. If there is no beneficiary designation, then the money will be distributed consistent with the beneficiaries of your VIP Plan.
Perhaps one of the most important considerations when deciding to participate is your unique financial situation. Some factors to consider include your current age, current savings, need for funds before retirement, when you expect to retire and current and future tax rates.
As a general rule, the younger you are and longer time you have to save, the more benefit there is to defer. The same rule that applies to starting your retirement savings early and compounding money over a long time period applies to 3M’s deferred compensation plans. However, when compared to saving in your VIP or GESPP, the period to save is usually shorter and the payout period more condensed.
Another factor to consider is if you have a need for funds now and if you are maximizing other saving opportunities. Contributing the maximum of $19,500 to the VIP (plus $6,500 for Age 50+ catchup) is an important first step before considering whether to contribute to the deferred compensation plans.
Additionally, if you think you may need the funds before retirement for college costs, home projects, or other goals, saving extra money to either a cash or brokerage account, will provide you with more flexibility. Remember that while you are always 100% vested in your balance, no loans are allowed8 from either deferred compensation plan.
If you have 5 years or less to retirement, it may not be that beneficial to defer. However, if you know you are going to exercise a large stock option award or expect a large RSU award to vest in a year of deferral, it may make sense to defer more in those years to reduce taxable income.
When determining whether to participate, consider your expected tax rates both in the current year and years following retirement. You want to be careful to avoid deferring so much that income is higher in retirement than while working. If you will be receiving a pension benefit, exercising stock options, or receiving required minimum distributions, while also receiving payouts from deferred compensation plans, your income tax rate may be the same or more than while you are working. This scenario provides limited benefit to deferring additional income.
If you are in Portfolio III and do not have a pension benefit, you may want additional sources of income available at retirement. Maybe your spouse will continue to work after you have retired and payouts from deferred compensation plans will allow you to delay drawing from other retirement funds.
Finally, if you think there is a good possibility of leaving 3M prior to retirement, it may not be beneficial for you to contribute. The resulting lump sum payout of the benefits at separation may cause you to pay taxes at a higher rate than when you deferred.
Bob was promoted this year. He just received notification that he is eligible to contribute to 3M’s deferred compensation plans for the first time in 2021. While his income has increased considerably since last year, his planned cash compensation is $295,000 for 2021. This puts him just above the qualified plan compensation limit of $290,000. He will be allowed to defer, but the deferral will be minimal. If he contributes 7% to both his VIP and VIP Excess, he will contribute the maximum $19,500 to his VIP and then his contributions will go to VIP Excess. Due to the relatively small amount he can contribute, Bob may decide not to participate in a deferred compensation plan for 2021 but reassess if he wants to participate as his income continues to increase. However, if Bob wanted to participate, the VIP Excess plan seems like the best option because he would also receive a 3M match on his contribution.
Molly has participated in VIP Excess in the past. Her planned cash compensation is $425,000 in 2021. In 2021, she has restricted stock units vesting and also is planning to exercise stock options. Molly plans to contribute to the VIP Excess plan again this year and receive 3M’s matching contribution. However, because she expects to have high taxable income, she also plans to contribute part of her base salary to the Deferred Compensation Excess plan. She expects her income in retirement will be lower than 2021, so deferring income now is a good option for her.
Enrollment is open from November 16 – December 4, 2020.
As you can see, making a choice on deferred compensation is complicated and factoring in your individual situation is important.
We want you to feel confident in the financial decisions you are making for 3M’s deferred compensation plans. Please reach out if you would like additional assistance on how these benefits apply to your unique financial situation. As always, it is our pleasure to serve you.
1 Non-qualified plans are not subject to contribution limits, salary limits and nondiscrimination rules imposed by qualified plans. The plans are typically not funded, and participants become general creditors of the company.
2 Planned Cash Compensation is defined as base pay plus variable play. It does not include income from restricted stock or stock options.
3 Qualified Plans are required to follow rules under ERISA and the Internal Revenue code. The contributions, salary limits and other rules must be adhered to. The 3M VIP is an example of a qualified plan.
4 The Personal Choice Retirement Account (PCRA) is a brokerage option available through your VIP that is administered by Charles Schwab and allows for additional investment options beyond what is provided by the core VIP investment options.
5 FICA taxes include Social Security and Medicare taxes.
6 Assumes Minnesota residency at time of deferral and current tax law. Future tax law changes may change taxation of deferred compensation plans based on incomes in excess of qualified plan limits. Minnesota’s highest state income tax rate is currently 9.85% and Florida has no state income tax.
7 The Deferred Compensation Excess plan also allows distributions while working as early as the January following a full 12-month period after deferral.
8 You may be allowed to take out funds in an emergency.