A strategic approach to retirement planning for today’s executives
Highly valued, successful executives are often offered additional benefits above and beyond those offered to other employees. This is typically done to reward them, but many companies also use these additional benefits to retain their executives in highly competitive employment markets. Deferred Compensation is a perfect example. It has become a powerful tool not just for employers but for those executives who understand how to maximize the benefit of this unique strategy.
Understanding Deferred Compensation
Deferred Compensation refers to a compensation arrangement where a portion of an executive’s earnings is withheld by their employer and paid out at a later date, often upon retirement or another predetermined event. This deferred income can take various forms, including stock options, restricted stock units, or cash bonuses. Unlike traditional compensation, which is immediately received and taxed, Deferred Compensation offers executives the advantage of deferring taxes until the funds are distributed.
Advantages of Deferred Compensation
Tax Deferral: One of the most significant advantages of Deferred Compensation is the ability to postpone taxes on the income until a later date, typically retirement. By deferring taxes, executives can potentially lower their current tax burden, allowing for greater flexibility in managing their finances and investments.
Asset Protection: Deferred Compensation plans often provide executives with a level of asset protection. In the event of bankruptcy or legal claims, these assets may be shielded from creditors, offering executives added security and peace of mind.
Supplemental Retirement Income: For executives seeking to enhance their retirement savings beyond traditional retirement plans such as 401(k)s or IRAs, Deferred Compensation serves as a valuable supplemental income stream. The ability to defer a portion of their compensation allows executives to build a robust financial portfolio tailored to their long-term retirement goals.
Employer Matching and Incentives: Many Deferred Compensation plans offer employer matching contributions or incentives, further incentivizing executives to participate in these programs. These additional contributions can significantly boost the executive’s retirement savings over time, amplifying the benefits of participating in Deferred Compensation plans.
Flexible Distribution Options: Deferred Compensation plans often provide executives with flexibility in determining the timing and structure of distributions. Executives can choose to receive distributions as lump sums, periodic payments, or annuities, allowing for customized income strategies aligned with their retirement objectives.
Income Bridge: Deferred Compensation payouts can be a Godsend when starting your own business, retiring early or having a discernible break in income. They can provide a valuable bridge until your new income kicks in, or other sources become available on a more tax efficient basis (i.e. age 59 ½).
Factors to Consider
Unintentional triggers
One of the most common triggers for deferred compensation plans to begin paying out is leaving your current employer. Even long before retirement. So, it’s critical to explore your plan’s specific triggers and payout requirements to understand what truly lies ahead or you may just be getting a very unpleasant tax bill come next April 15!
Selecting a Payment Timeframe
Most plans require that the length and schedule of the payments be selected at the time of ELECTION, not payout. This is to maintain their more favorable tax treatment and frankly, to simplify the administration of these plans. Therefore, it is important to have a solid plan in place for when you want or need this income in the future and avoiding this income being triggered at a rate that makes an already high tax rate even worse. Working with Ignite Financial, we will help you establish a plan for when and how much income may be needed based on your long-term goals and your employment trajectory (how often do you change jobs). We can recommend the optimal timing that most closely aligns with your needs and minimize any negative effects.
Plan That Income
When determining the timing of when your deferred compensation will kick in, consider how you could use the income. Have some flexibility on when it starts? Consider pushing the start back. Pushing the start back even a few months could lower the income you recognize that year and limit the taxes due.
Taxes?
One of the things to consider with Deferred Compensation is that while it benefits you during the deferral stage, receiving income while you are already taking income from another source (i.e. new job) can actually complicate an already complex tax situation. Understand your options, what you can do now to offset that income once it starts and get ahead of the tax monster coming in April. Charitable donations, bunching deductions, filing separately, there are things that can be done in advance. Good planning can go a long way in avoiding some very unpleasant experiences.
What if you don’t need it?
You may find yourself not needing the money, particularly when leaving your current employer for a promotion or higher paying role elsewhere. That means you take the tax hit without getting maximum value. We will help you get a plan in place to optimize the tax treatment of the funds and put them to work in a way that benefits you today and tomorrow.
Current vs. Future Tax Rate
Understanding the inner workings of your Deferred Compensation plan, it’s pluses and minuses, can be complex. While there are basic IRS guidelines all plans must meet, companies have leeway in setting up their own guidelines so plans can vary widely from employer to employer.
When deciding if, when or how much of your income to defer to your company plan, Ignite Financial can help you navigate the situation. We can help you avoid unnecessary pitfalls by modeling the impact to both your income and goals today, and the potential tax implications of any future decisions before you make them.