Should You Take Advantage of a Deferred Compensation Plan? (Published 2017) (2024)

FAQs

Should you take advantage of a deferred compensation plan? ›

If you plan on retiring early, a deferred compensation plan may be a good way to generate income after your early retirement but before you're eligible for IRA distributions and Social Security.

The plans carry some inherent risk for the employees in that the deferred payments are unsecured and not guaranteed. So if the organization faces bankruptcy and creditor claims, the employees may not receive their promised funds. (In contrast, qualified plans such as 401(k)s are protected from bankruptcy creditors).

Deferred compensation plans are available mainly to high-income earners who want to put away funds for retirement and find the company 401(k) plan inadequate to their needs.

More info asked on W2 Box 12 Code G: "Did you elect to have your employer make contributions to your deferred compensation plan,” What we mean here is did you request that your employer contribute money from your paycheck to your deferred compensation plan. If this sounds like your situation, select Yes.

Receiving your deferred compensation in installments over several years can reduce your tax bill, because the smaller installment payments will typically be taxed at a lower rate than a larger lump-sum payment will be.

The Benefits

Wealth management and wealth maximization are big parts of financial planning for most high earners. Participating in a deferred compensation plan can help a high income person's retirement situation immensely, allowing them to potentially retire much earlier than they otherwise could have.

Usually, those payments will not affect your Social Security benefit if they are for work done before you retired.

Assets in non-qualified plans belong to the employer, not the employee and can be seized by the employer's creditors. If you have an NQDC plan, the terms of your plan could mean that you forfeit all or part of your deferred compensation if you leave the company early.

Deferred compensation is a great way to reduce your tax liability and save for retirement, especially if you have reached the limit of your 401K contributions, but they come with their own unique set of rules that require thoughtful consideration.

Deferred compensation plans cannot generally be accessed early. Many workers may not be able to afford to defer compensation. Deferred compensation plans can be at risk if the company goes out of business or files for bankruptcy.

What to do with deferred comp after retirement? ›

We often advise clients to take deferred compensation distributions upon retirement and defer commencing Social Security. Each year of Social Security deferral equates to about an 8% annualized increase in benefits.

You can make rollovers between tax-deferred retirement plans – a 457(b) to an IRA, for example – without paying tax, assuming you cross every T and dot every I. If you transferred ​$125,000​ to a Roth IRA, however, you'd pay tax on that money and then withdraw it tax-free down the road.

You generally have to start taking withdrawals from your IRA, SIMPLE IRA, SEP IRA, or retirement plan account when you reach age 73. Check with your plan to find out how this will work for you. Your required minimum distribution is the minimum amount you must withdraw from your account each year.

For example, the Internal Revenue Code (IRC) allows for 401(k) withdrawals to begin penalty-free after age 59½—but the IRC also requires that you start taking distributions at age 73.

An employer reports to an employee the total amount of deferrals for the year under a nonqualified deferred compensation plan in box 12 of Form W-2 using code Y.

Deferred compensation reported on a W-2 form for 1 year but earned in a previous year is also considered a special payment. Usually, those payments will not affect your Social Security benefit if it's for work done before you retired.

The Bottom Line

If you have a qualified plan and have passed the vesting period, your deferred compensation is yours, even if you quit with no notice on very bad terms. If you have a non-qualified plan, you may have to forfeit all of your deferred compensation by quitting depending on your plan's specific terms.