Today on Market Vizion, we're going to talk about your deferred compensation plan.
Many of our clients have access to executive deferred comp plans. You're given an opportunity once a year, usually in the third or fourth quarter, to opt into the deferred comp plan for next year.
Usually, this means not only are you trying to do your family budget and plan family vacations and all that kind of stuff. You're also trying to figure out what part of next year's compensation should you be putting away until some indeterminate point in the future.
Yes, You Really Can OveruseYour Deferred Compensation Plan
In my experience, most often people choose a lump sum at retirement or defer that money into an account that maybe is going to pay out during the first 10 years of retirement to help with cashflow for those first 10 years of retirement.
What I've been seeing happening though is that our clients have been more transient. They're moving between companies, and as a result, these things very often get paid out as lump sums when you leave your company.
It's because of this that I want to caution against overusing these plans. I had a client early on in my career who was just so jazzed that he put away 100% of his bonus and 25% of his income every year for 18 years before I met him. He had about a $3.5 million plan balance.
We strongly curtailed how much he was putting into the plan, but when he left the company, he still had $6.5 million in the plan. And guess what?
It all came out at one time and it all got taxed at the maximum tax bracket! Obviously not ideal...
Why (and When) Should I Use an Executive Comp Deferred Plan?
As you move passed the income threshold for the IRS (which right now is around $285K including your base plus your bonus), it's important to utilize it for comp plan for a specific purpose.
Many times and in many companies (not all), companies will continue matching your contributions to the deferred comp plan once they're no longer allowed to contribute into the 401(k).
This is a non-qualified plan and very often, companies will continue to match dollars contributed above that internal revenue code income threshold.
Using Executive Comp Plans for Big Expenses
You may have specific years where you just know you're going to have a lot of expenses that year. I'll give you a personal example.
In my world, I had my 25th wedding anniversary and my daughter starting college both in the same year. So what did I do? I put about 75 grand into my deferred comp plan to come out and be paid out that year. Why? Because I figured with those two huge unknowns on my schedule, I figured having an extra $75K available as income that year would not be a bad thing.
You can use these plans very strategically if there's a specific year where you know you're going to have some really high expenses, especially one-off expenses.
The big challenge though is the question of changing companies. Either way, we strategically use these plans to prepare, but we know that fate often has different outcomes than what our plans provide for.
The bottom line for me is this: we use deferred comp plans strategically for clients to make sure we are maximizing the match from the company and to strategically plan for major events or big expense years we know are coming in the years ahead.
Using Deferred Comp Plans to Manage Your Tax Bracket
The final reason we use these plans is for clients who are trying to defer and stay out of a top tax bracket.
Personally, I feel there are other strategies that can be better utilized to help manage your tax bracket when you're in those really high-income years. There's other things that are affected in your tax bracket and in your taxable income – things like over exposure to company stock – that probably can have more bang for your buck than over utilizing a deferred comp plan.
Getting Advice Unique to You
Every client and every situation are a little bit different and warrant a customized approach. Here at Vizionary Wealth Management, we're always here with perspective for the decisions ahead. If we can help you with your strategy around deferred comp plans or any other area of your planning, please don't hesitate to reach out. Have a great day.