So, you’ve been climbing the career ladder and bringing in some solid paychecks? Nice! But now HR’s dangled a little something in front of you: a deferred compensation plan. It sounds fancy, and I get why it might be tempting. But before you dive in, let this old-timer share a few things I’ve learned from my own experience.
What Exactly Is Deferred Compensation?
Basically, it’s a way to set aside a chunk of your paycheck now and take it later, usually when you retire. Why would you do that? Well, the big idea is that you’ll probably be making less money when you retire, so you won’t owe as much in taxes when you finally withdraw it.
Sounds ok, right? Hold up though—there’s a catch. You have to decide up front how you’re going to invest that money and when to take it out. And once you make those choices, you’re stuck. There’s not much room to change your mind later, unlike with your 401(k).
Should You Really Sign Up?
Before you go signing on the dotted line, ask yourself a few key questions:
1. Is your company rock-solid?
Listen, a deferred compensation plan is like saying, “Here, boss, hold onto my money for me.” If your company goes belly up, there’s a chance you might lose everything you deferred. It’s not protected like your 401(k), and you can kiss that IOU goodbye.
2. How much of your money is already tied to the company?
Got stock options? Restricted stock units (RSUs)? Maybe you’re part of a stock purchase plan? All those things are tied to the company’s future, just like deferred comp. Putting more eggs in that same basket can be risky.
3. How soon are you retiring?
If you’re more than 15 years out from retirement, it’s hard to predict where your company’s going to be. I mean, no one saw General Electric hitting financial trouble a decade ago, right?
4. What’s your tax situation?
Deferring money might push you into a lower tax bracket now, and that could save you some cash. But the trick is thinking ahead: where’s your tax bracket going to be when you retire? It’s tough to say with tax laws changing all the time. I had a buddy who deferred $30,000 one year and saved himself about $2,400 in taxes. Not bad, but it’s not a guaranteed win every time.
The Two Big Decisions
If you decide to jump into a deferred comp plan, you’ve got two major decisions to make: **when** to take the money out and **how** to do it. These choices are locked in, so think it through.
A. When are you going to take it out?
The smart play is to wait until you’re retired. Why? Because you’ll probably be making less money by then, and that means less tax to pay when you finally take the cash. Now, sometimes life throws curveballs. In some cases, the triggers for deferred comp distribution are beyond your control. For example, in most cases you (or your heirs) will be forced to take distributions upon a separation of service, death or disability.
B. How are you going to take the money?
Most plans give you two choices: a lump sum or payments spread out over a few years. This is where timing is everything. You don’t want to start pulling cash until you’re done working.
Here’s what you need to keep in mind
– **When do you plan to retire?** Make sure you’re actually retired before the money starts flowing.
– **What about Social Security?** A lot of financial advisors suggest taking your deferred comp first and delaying Social Security as long as you can. Waiting boosts your Social Security benefits by about 8% per year, which is pretty sweet. A good advisor will analyze the pros and cons with you.
– **Can you survive off your deferred comp and other savings until you hit 70½?** At that point, Uncle Sam’s going to force you to start pulling money out of your 401(k) and IRA.
– **Lump sum or spread it out?** Whether you take one big payout or smaller ones over time depends on your retirement plan.
Final Words of Wisdom
1. Get yourself a financial advisor
Trust me, you want a pro helping you with this. Navigating deferred comp isn’t something you want to wing.
2. Pick smart investments
Just like with your 401(k), you’ll probably get to pick how the money’s invested. If you can, think about lowering the risk as you get closer to retirement.
3. Make sure it fits your big picture
Deferred comp can be a great tool, but it’s not a standalone thing. You’ve got to fit it into your overall retirement plan.
Bottom line:
Deferred compensation can be a smart move if you play your cards right. Just make sure you know what you’re getting into, plan carefully, and always be sure it works with your bigger financial goals.
Interested in learning how a Deferred Comp plan impacts you specifically, reach out anytime. We’re here to help.
House Writer is not a registered investment advisor or broker/dealer and does not make security recommendations nor provide financial advice. Readers are advised that the material contained herein should be used solely for informational purposes, and to consult their personal tax and/or financial advisors as to its applicability to their circumstances. Investing involves risk, including the loss of principal.