*Originally published August 4, 2023
David Totah, CFP®, Partner and Senior Wealth Advisor
Amidst the complex world of financial planning, deferred compensation is a much-discussed topic lately. Simply put, deferred compensation is a form of compensation that is designed to allow a designated class of executives to save above and beyond the typical 401k limits. These plans generally distribute the funds when the individual retires or in a specified time period. It is a highly customized plan that is implemented by companies for their higher-level management employees. However, the implementation of such plans involves several considerations that may not be obvious. In this blog post, we will delve into the factors to consider when contemplating deferred compensation plans.
Taxable income consideration now and in retirement:
Your taxable income is one of the key aspects to consider when determining if you should contribute to a deferred compensation plan. If your current income is high, deferred compensation plans can make a lot of sense since your income is reduced by the amount you contribute to the plan. Careful planning is necessary to ensure your taxable income in retirement does not exceed certain thresholds that would require you to pay more taxes than you had planned to or can afford. Tax-efficient investment strategies can help mitigate these risks.
Review cash flow needs during working years and nearing retirement:
It is important to consider your cash flow needs during the working years and compare those to your cash flow needs in retirement. Deferred compensation plans are typically structured to pay out in installments over a particular time period, ie 10 years for example. Determining which payout structure works best for your needs is critical. Additionally, it’s important to consider whether other sources of income, such as Social Security and pension plans, will provide the desired cash flow during retirement.
Consider concentration risk in any investment in deferred compensation plans:
Since deferred compensation plans are not guaranteed, it’s important to consider concentration risk when evaluating the investment options offered by your employer. Concentration risk refers to the possibility of incurring losses when a significant portion of your investment is in a single asset or stock. Although this may maximize returns, it also exposes you to a greater risk of loss. A diversified portfolio can help mitigate these risks.
Deferred compensation plans differ from 401k, not guaranteed:
It’s crucial to know the differences between 401(k) and deferred compensation plans. Deferred compensation plans are not guaranteed but can offer much higher income tax deferral than what a 401k allows. Explore all available options when considering investment options to determine which plan is best suited for your needs.
Assist with exaction and management of plan and yearly elections:
It’s important to stay up to date on administrative tasks to maximize available investment opportunities and avoid costly mistakes.
As you can see, there are several factors to consider before signing up for a deferred compensation plan offered by your employer. By reviewing taxable income, cash flow needs, concentration risk, and differentiating between deferred compensation and 401(k) plans, you’ll be able to determine whether or not this option is right for you. If you're looking for a trusted advisor who can help you navigate the complexities of deferred compensation plans, look no further than Exencial Wealth Advisors. Our team of professionals can help guide you through the process for maximum investment success, security, and peace of mind.
Disclaimer: The information provided in this article is for educational purposes only and should not be considered as financial or legal advice. Please consult with your financial advisor for personalized advice.
Exencial Wealth Advisors is an SEC-registered investment adviser. Any references to the terms “registered investment adviser” or “registered,” do not imply that Exencial or any person associated with Exencial has achieved a certain level of skill or training.