Deferred Compensation: What You Need to Know
By Roxanne Martens, CFP®
Saving for retirement can be a challenge for high-income earners like corporate executives and physicians. The annual limits on 401(k)s and IRAs mean you can only save so much, and income phase-outs can cut into the tax benefits of saving for retirement.
This leaves many executives worried they won’t save enough for their future needs. However, there is a solution: deferred compensation plans. Many companies offer these plans to help executives and physicians save more for retirement while also lowering their current year taxable income. The catch is that these plans can be complicated, leaving you wondering if deferred compensation is really a good idea.
Let’s review the pros and cons.
What Is Deferred Compensation?
Deferred compensation is an arrangement with your employer where you decide to set aside part of your current income to be paid out later, usually when you retire. The best part? That money grows tax-deferred, meaning you won’t pay taxes on it until distribution. This can be an attractive option if you’re a high-income earner trying to lower your taxable income during your peak earning years.
Hospitals often offer physicians a range of deferred compensation plans, including Non-Qualified Deferred Compensation (NQDC) plans and 457(b) or 457(f) plans, which allow for additional savings beyond traditional retirement accounts. Each plan comes with its own set of rules and tax implications, making it crucial to carefully evaluate which option best aligns with your long-term financial goals.
Corporate executives, such as those at companies like Walmart, are also typically offered NQDC plans. These plans often include features like salary deferral, bonus deferral, and stock option deferral programs that allow executives to defer taxes on large bonuses or equity compensation until they retire or leave the company. This can be particularly beneficial in managing both income and taxes during peak earning years.
The Pros of Deferred Compensation
For high earners, deferred compensation plans can be a smart way to save for retirement once you’ve maxed out other options. Not only do these plans come without contribution limits, but they also offer several other attractive benefits:
Tax Deferral
One of the biggest advantages of deferred compensation is the ability to defer taxes. By postponing your income, you may be able to lower your tax bracket in the year the income is earned, which could result in tax savings over time. The deferred income will be taxed when you receive it, ideally when you’re in a lower tax bracket during retirement.
Compounding Growth
Because the income in a deferred compensation plan grows tax-deferred, you have the potential to accumulate more wealth over time. The money that would have gone to taxes can instead remain invested, allowing it to grow.
Retirement Planning
Deferred compensation plans can also be an excellent supplement to other retirement accounts, such as 401(k)s or IRAs. They provide an additional vehicle to save for retirement, especially if you’ve already maxed out contributions to other tax-advantaged accounts.
Employer Incentives
Some employers may offer matching contributions or other incentives for participating in a deferred compensation plan, making the benefits of the plan even more attractive.
The Cons of Deferred Compensation
While deferred compensation plans can be a great addition to your wealth management strategy, it’s important to keep a few things in mind before committing:
Risk of Employer Insolvency
Deferred compensation plans are often considered unsecured promises by the employer to pay the employee in the future. If the employer faces financial difficulties or goes bankrupt, there’s a risk that you may not receive the deferred compensation. Unlike qualified retirement plans, deferred compensation is not protected by ERISA (Employee Retirement Income Security Act).
Lack of Access to Funds
Oftentimes deferred compensation plans restrict access to your funds until a specified future date, such as retirement, and they have a fixed distribution schedule that you must commit to upfront. If you need the money earlier due to an emergency, you may not be able to access it without significant penalties or restrictions.
Potential Tax Rate Increase
While the goal of deferred compensation is to pay taxes at a lower rate in the future, there’s no guarantee you’ll be in a lower tax bracket during retirement. If tax rates increase or your income remains high, it’s possible you could end up paying more in taxes than anticipated.
Limited Investment Options
Some deferred compensation plans may offer limited investment choices compared to other retirement accounts. This is one reason why they are often combined with other retirement strategies not tied to your company. Why? Because as a physician or corporate executive at Walmart, you might have too much of your wealth tied up in your employer’s stock. This lack of flexibility and diversification could increase your risk and impact your ability to tailor your investment strategy to your specific financial goals.
We’re Here to Guide Your Steps
Figuring out deferred compensation plans and whether they make sense in your overall financial plan can seem like a puzzle to solve. At CGN Advisors, we’re here to help you tackle your retirement planning challenges and put the pieces together in a way that fits your lifestyle and goals. We know that a financial plan is a long-term strategy that may have many iterations along the way—we’re in it with you for the long haul. With our combined decades of experience, we’re familiar with the ins and outs of safeguarding your wealth from risks that may come with deferred compensation.
Want to know more about our personalized financial planning and if we’re the right fit for you? Reach out to us and schedule a meeting, by calling our Manhattan, KS, office at (785) 340-3434 or our Rogers, AR, office at (479) 335-1034.
About Roxanne
Roxanne Martens is a CERTIFIED FINANCIAL PLANNER® professional and serves as a Lead Financial Advisor on the team at CGN Advisors, a Fee-Only, financial advisory firm based in Manhattan, Kansas. Roxanne works out of CGN’s Arkansas location, serving clients in the Rogers, Bentonville, Springdale, and Fayetteville areas. An advisor since 2020, she works with both young professionals and those approaching retirement by helping them utilize their growing income efficiently and facilitating strategic cash flows once their regular earned income ends. She enjoys using her skill set to educate and guide clients through life as they make financial decisions and set goals. Roxanne says, “Comprehensive financial planning and investment management takes a lot of trust from the client, and I don’t take that lightly. I genuinely want each of my clients to succeed.” Her favorite aspect of her role is connecting with clients on a personal level, providing clarity and peace, and being able to witness them realize their dreams.
Roxanne obtained her master’s degree in personal financial planning from Kansas State University and holds the CFP® designation. Prior to becoming a financial advisor, she taught in the Personal Financial Planning program at Kansas State University for seven years. As a mom with young children, most of her free time is spent with her husband, John, and two sons, Johnny and Judd. They enjoy living life outdoors—bike rides and spending time at the lake or pool. To learn more about Roxanne, connect with her on LinkedIn.
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