- October 6, 2021
Eligibility for 3M Deferred Compensation Plans
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 planned cash compensation for 2021 is $350,000, comprised of $270,000 base salary and $80,000 variable pay, and a 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, an individual needs to be employed by 3M. For the VIP Excess plan, an equal percentage needs to be contributed to the VIP plan. 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 planned cash compensation exceeds the qualified plan limits as of November 1st of the immediately preceding year and will be re-evaluated each year.
3M VIP Excess vs. Deferred Compensation Excess
There are many different characteristics to compare and contrast between the two plans that 3M offers
VIP Excess allows whole percentage contributions between 2% and 10%. The same contribution percentage must be directed to VIP and VIP Excess. For instance, a 7% VIP Excess contribution must be accompanied by a 7% allocation to VIP.
The VIP Excess contribution begins at the earlier of when the maximum VIP deferral for the year, $19,500 for 2021, is met or when compensation reaches $290,000. The election to participate in VIP and VIP Excess is 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.
Does 3M Contribute?
3M provides a match on VIP Excess contributions in the same matching percentage as the 3M VIP. The amount of the match is determined by Portfolio eligibility. Additionally, Portfolio III employees are eligible for a 3% non-elective contribution.
3M does not provide any contributions or match to the Deferred Compensation Excess plan.
Both VIP Excess and Deferred Compensation Excess have the same investment options. 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 (a type of investment focused on capital preservation) that is not available in the VIP Plan.
Because this is a non-qualified plan, the funds are not actually invested. Instead, the plan balances are adjusted to reflect performance as if the funds were invested.
Participation in 3M Deferred Compensation Plans
There are many factors to consider when determining whether to participate in 3M’s deferred compensation plans.
The tax implications are the same for each plan.
Federal income taxes are deferred on the contribution amount and on the ongoing earnings in the funds 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. As long as supplemental wage income is not in excess of $1M, 22% federal withholding and 6.25% Minnesota withholding are the applicable withholding rates (or state of residence rate). When distributions are made, additional taxes may need to be paid or withholdings adjusted to ensure enough tax is paid in.
Funds are Unsecured
In order for a non-qualified plan to receive tax deferral, no separate trust fund or assets can be set aside. Therefore, participation results in becoming an unsecured creditor of 3M. This differs from the VIP Plan where a separate account is owned and is protected from creditors of 3M. These plans are also unfunded, which means 3M’s ability to pay accrued benefit depends upon its current and future financial health.
Impact on Pension Benefit
There is no impact on total pension benefits 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 the qualified pension was reduced.
Each year of participation requires a separate payout election. Payout options do not need to be the same as prior elections and can change from year to year. However, once a payout option is selected for the year, it is irrevocable.
Both the timing of the distribution and the form of the distribution need to be elected. The payments can begin one to ten years post retirement6. All payments must be made within ten years and the payments can be made as either a lump sum or a series of annual payments between two and ten payments.
The first payout will be based on the election and date of retirement, either January or July at least 6 months after retirement.
- A retirement date of April 1, 2021 results in the first payment in January 2022.
- A retirement date of October 1, 2021 results in the first payment in July 2022.
VIP Excess or Deferred Compensation Excess plan balances cannot be rolled into an IRA or any other tax-qualified plan. The amounts will instead be paid out based on the yearly elections that were made.
Leaving 3M before retirement, which is defined as before Age 55 and 5 years of service, requires payout as a single lump sum in either January or July, depending upon date of separation.
Death before payments begin will result in a lump sum payment to beneficiaries in January of July of the following year, depending on date of death.
Death after payments begin results in the remaining balance paid to beneficiaries on the same schedule as the payments already made.
Beneficiaries must be the same for VIP Excess and Deferred Compensation Excess. If there is no beneficiary designation, then the money will be distributed based on beneficiaries on the VIP Plan.
Perhaps one of the most important considerations when deciding to participate is each person’s unique financial situation. Some factors to consider include current age, current savings, need for funds before retirement, expected retirement date and current and future tax rates.
As a general rule, the more time there is to save, the more benefit there is to a decision to defer. The same rule that applies to starting retirement savings early and compounding money over a long time period applies to 3M’s deferred compensation plans. However, when compared to saving in the VIP or GESPP, the period to save is usually shorter and the payout period more condensed.
Another factor to consider is the need for funds now and if other saving opportunities are maximized. 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 the funds may be needed before retirement for college costs, home projects, or other goals, saving extra money to either a cash or brokerage account, will provide more flexibility. While the account balance is always 100% vested, no loans are allowed7.
If there are 5 years or less to retirement, it may not be that beneficial to defer. However, if a large stock option award will be exercised or a large RSU award will 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, the expected tax rates both in the current year and years following retirement are important to consider. Care should be taken to avoid deferring so much that income is higher in retirement than while working. If there will be a pension benefit, exercising stock options, or receiving required minimum distributions, while also receiving payouts from deferred compensation plans, the applicable income tax rate may be the same or more than while working. This scenario provides limited benefit to deferring additional income.
Employees in Portfolio III that do not have a pension benefit may want additional sources of income available at retirement. If a spouse will continue to work (or other sources of income are available) and payouts from deferred compensation plans will allow drawing from other retirement funds to be delayed, it may be an option to consider.
Finally, if leaving 3M prior to retirement is a possibility, participation may not be beneficial. The resulting lump sum payout of the benefits at separation may cause taxes to be paid at a higher rate than if there wasn’t the deferral.
3M Deferred Compensation Case Studies
Bob’s Increased Income
Bob was promoted in 2021. He just received notification that he is eligible to contribute to 3M’s deferred compensation plans for the first time in 2022. 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 2022 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’s Tax Consideration
Molly has participated in VIP Excess in the past. Her planned cash compensation is $425,000 in 2022. In 2022, 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 2022, so deferring income now is a good option for her.
Enrollment is typically open from mid-November through early December.
3M Non-Qualified Pension Plan
Some employees, with planned compensation in excess of the qualified plan limits, are also eligible for 3M’s non-qualified pension plan. The purpose of this plan is to provide additional retirement benefits because annual compensation limits restrict the amount that can be allocated to a qualified pension plan. Non-qualified pension retirement benefits are calculated on earnings in excess of these thresholds and are solely funded by 3M.
Non-qualified pension plan benefits are paid out as a lump sum at retirement. However, some individuals had a one-time irrevocable opportunity in 2008 to elect to receive their benefit as an annuity at retirement.
Departure from 3M prior to age 55 will result in the NQ pension benefit being void. For some, the benefit is small and will not be material, however for others this could be a significant loss.
State Income Taxes and 3M Compensation
The non-qualified pension and excess plans offered by 3M present an opportunity to shift income to a different state in retirement8. These benefits will be taxed to the state of residence at the time of receipt. If a move to a low or no-income tax state (i.e. Florida) is a possibility in retirement, there could be a significant amount of money saved by participating in these plans.
Making a choice on deferred compensation is complicated. It is important to consider and factor in an individual’s unique situation when determining participation in either plan.
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 The Deferred Compensation Excess plan also allows distributions while working as early as the January following a full 12-month period after deferral.
7You may be allowed to take out funds in an emergency.
8 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.