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Investment Planning |
Deferred Compensation
Deferred compensation plans are an excellent way to save for retirement, since the contributions that you and your employer make to the plan, plus earnings and growth on the funds, are tax-deferred until you withdraw the funds. Many plans allow for withdrawals after you terminate from your job or at a specific age that you choose. For example, you may choose to receive payouts from your deferred comp plan for five years after you leave the company. Since you may leave the company well before retirement, say for example when you're age 38, or 48, for a job change, your deferred comp payout may push you into a higher tax bracket at a time when you don't need any excess cash. The tax bracket that you're in when the funds are distributed determines how much tax you pay on the money. Generally, it's best to defer the payouts until you're retired, but there's some danger to that, especially if retirement is a long time away.
If you have doubts about the viability of your company to continue as a strong, healthy entity, you may not want to participate in the deferred comp plan. Deferred comp plans are unfunded, meaning that payments from the plan to you (in future years) will be made from your company's general assts. With a deferred comp plan, you will not have a separate account in your name, as you do with your 401(k) account. This is much different from a 401(k) account which is yours, and the balance in the account is guaranteed to be paid to you. Your assets in a deferred comp plan are part of a large pool, and your account balance is usually based upon the performance of mutual funds you choose that are used for tracking purposes (you will not actually hold these funds). You'll have the same status as that of an unsecured creditor, meaning that you may not see this money in the event of the company's bankruptcy.
If you believe in your company's strength, and are close to retirement, consider participating in the deferred comp plan. If you have doubts about the company's viability or are a long way from retirement, calculate the risks versus the potential benefits of deferring your compensation.
Tips Disclaimer
These tips contain information that may change over time as a result of new tax legislation. Although we make efforts to keep this information current, you should check with your tax advisor before taking action based upon any information contained in these tips.