How to Plan for Deferred Compensation in Retirement [Video]

Deferred compensation can feel like a silver bullet. You lower your taxes today and you have smoother income in retirement. But without the right planning, it can actually create a series of tax consequences that are difficult or even impossible to undo.

Video Transcript

Hello, my name is Michelle and I’m a financial advisor here at Financial Design Studio. We help business professionals retire in a tax-efficient way. If retirement is getting close for you, we have a free retirement planning guide that you can download, which is linked below.

In this video, we’re going to talk about how deferred compensation is just one piece of income that business leaders have and how it fits in the big picture of your retirement.

What is Deferred Compensation?

Let’s say today you’re earning $100,000 and you don’t need all of that income. You want to lower your taxes and you want money in the future. So you say, of that $100,000, I want to elect to defer $20,000 of my paycheck into the future. I’m only going to receive $80,000 today. Great, that will lower your income taxes today and then in the future at some point in retirement, you’ll receive that $20,000.

This is a benefit that really is offered to kind of senior executive level business professionals who are in leadership roles. And so it’s not necessarily something that just anyone can use. So that’s why they’re earning higher levels of income. They want to give them the opportunity or the ability to defer that into the future for some of their tax planning today. That’s really why someone would choose to use deferred compensation.

What Are the Risks of Deferred Compensation?

Well, you’re deferring this money into the future rather than taking it home today and keeping it in your pocket where you can spend it when and on whatever you want to. So someone is holding those funds for you, which is your company. They’re holding those funds for you and they’re set aside for you. However, these are still funds of the company. So they are subject to creditor claims if something should happen, like the company goes bankrupt.

This is why you really need to think about the company that you work for, the stability of the company and things like that when you’re electing an option like this.

Should You Work With an Advisor?

One of the biggest things that I would say is if you have the option of deferred compensation and if you are thinking about using it, that is a sign that you should be working with a financial advisor. This is a benefit that takes many years of planning well into the future and today and you really want to get it right because it impacts your taxes today and in the future.

And to make changes to these elections can actually push the funds you receive even further into the future when really you needed them sooner. this is a benefit you want to use, are planning to use, or are, that you’re getting some help to plan this out well.

We have written a really detailed article about deferred compensation and many more of the specific nuances with it and some examples that you can see that might impact you as well. So if you want to get that article, it’s linked down below as well.

What Other Income Do You Have to Plan for?

So let’s say that you’ve decided to elect deferred compensation. One of the things that you need to really consider or be aware of are the income sources that you’re going to have in retirement at different ages. So let’s just list several of these as you start to think through whether this is a great idea for you. –

• Some of these business professionals are receiving things like stock options or RSUs, so that restricted stock units that might even continue once you retire.
• Others might be investment accounts that you’re pulling from. So these could be brokerage accounts that you have funds saved into and to allow your tax deferred accounts to continue to grow you’re going to actually pull from those investment accounts maybe first so that can be income or assets there.
• Another is social security and again this can be anywhere from ages 62 to age 70. So that’s something that you want to consider again when to take and when that should start and how it’s going to impact these other sources of income.
• Others are your required minimum distribution. So RMDs that start at age 73 or beyond depending on your age. So depending on when you need to start that, depending on your date of birth, is when those RMDs will need to be calculated and factored into your tax timeline as well.
• And then like we’re talking about now on top of this is your deferred compensation elections.

Depending on what you’ve chosen, and in what year, you’re going to receive those that’s when you have to kind of factor in what years you’re going to be receiving this. So it could be even a chart just very simple to kind of help you understand.

Maybe when you first retire you’re going to be getting those stock options and restricted stock units. Maybe you’re going to be using your investment accounts where you can manage some tax impact there and maybe your deferred comp elections will start right away but then you have some of these other things like social security and RMDs and maybe those will start several years later.

What Are You Planning For?

Now the reason that we talk about that tax timeline is because it depends on what you’re planning at each of these ages and stages in your career and retirement.

• So are you looking for tax savings? Maybe that’s something today you’re looking for, but maybe that’s also something that you’re looking for in retirement because maybe you have large 401k balances and retirement income like pensions or social security, pieces like that.
• Maybe you’re looking to do Roth conversion. So there’s a window of time maybe before some of that income starts again depending on what you choose and when you choose, maybe there’s a gap that you can actually use a strategy like that.
• Maybe there’s gifting opportunities, so whether that’s to your kids for college, whether that’s grandkids, whatever those opportunities might be, or just even charitably, those can be paired with some of these tax strategies as well.
• And then maybe you have years where there’s high medical expenses, so all of these things can impact one another when we start to think about taxes

So the decision you make with your deferred compensation elections will impact your life 10 to 20 years from now. It’s something you definitely want to get right. That’s why people who are nearing retirement work with financial advisors like us who manage investments alongside comprehensive planning. This is how you create a tax-efficient retirement.

Your Next Steps

And if you want a team of financial advisors to support your retirement plan, this is what we do best. Our team specializes in tax efficient retirement planning for individuals with executive compensation. So you stay on track all year, every year, reach out to our team at to schedule a 30 minute consultation.

We’ll see you there or in the next video!

Bonus: Our Free Retirement Planning Guide!