By Mike Collopy, CFP®, CIMA®

If you’re a high-income earner, like a physician or corporate executive, you’ve likely heard of deferred compensation plans. These retirement plans, often offered through your employer, are popular because they can save you a significant amount of money, both in retirement and during your working years. With these plans, you can defer a portion of your income to the plan, where it can grow tax-deferred.

At first glance, this may seem like an attractive option for high-income earners. After all, any opportunity to defer current-year taxation is appealing, right? Well, yes and no. While deferred compensation plans offer several advantages, there are also some drawbacks to consider. Let’s explore the pros and cons to help you decide if this is the right choice for you.  

The Benefits of Deferred Compensation Plans

For highly paid professionals, deferred compensation plans can be a good way to save for retirement after maxing out contributions elsewhere because deferred compensation plans have no contribution limits. Consider these additional benefits:

Tax Mitigation Strategies

Do you live in a state with high-income tax but are considering retiring to a state with no income tax, like Texas or Florida? Deferred compensation plans help you save on your tax bill by allowing you to put more money into your plan and lower your tax bracket while you are working. You will not owe federal income tax on the funds contributed until they are withdrawn in retirement, typically when you are in a lower tax bracket. Additionally, if you are planning on moving to another state without an income tax for retirement, this could also provide some tax savings. 

Retirement Income Bridge

Deferred compensation plans can be used to generate income for a couple or individual as they begin retirement and want to maximize their Social Security income by delaying collecting it until age 70. It can also be used to supplement income in retirement if the market has taken a hit and your portfolio has suffered. 

Deferred Compensation Plan Drawbacks 

While the pros of deferred compensation plans seem like incredibly useful tools for your wealth management strategy, there are some points to consider when using a deferred compensation plan. 

Company Solvency Risks 

This may be the largest risk you can face when using a deferred compensation plan. If a company declares bankruptcy, your deferred compensation plan could be completely or partially dissolved in the bankruptcy. This is because when you participate in a deferred compensation plan, you are considered to be a creditor of the company. Also keep in mind that if you choose a longer-term payout option, this increases the risk that the company may go bankrupt during this time. You should closely examine your company’s plan and consult a trusted financial advisor before participating. 

Lump Sums Could Affect Your Taxes

Most plans do not allow you to access the money earlier than your retirement, however, if you change jobs, you may have to collect the money in one lump sum. Collecting one large lump sum could wreak havoc on your tax-mitigation strategy for that tax year.

Lack of Diversification

Deferred compensation should always be coupled with other retirement strategies that don’t involve your company. This is because as an executive, you may have an inordinate amount invested in your employer’s stock. If the company suffers an economic blow, your employer’s stock could lose value and your deferred compensation plan could also be in jeopardy. This could be devastating to your retirement plan.  

Work With a Trusted Professional

Understanding the details of deferred compensation plans can be challenging, but you don’t have to tackle these financial decisions all on your own. At Veracity Capital, we collaborate with our clients to address their retirement planning concerns and we recognize that your financial plan is a long-term endeavor. This is why we dedicate ourselves to supporting you every step of the way. With our extensive experience working with clients, we have the knowledge and resources to identify potential risks associated with deferred compensation plans and implement strategies to help safeguard your wealth.

To discover more about our approach to financial planning and determine if we’re the right fit to work together, schedule a complimentary introductory call by reaching out to me at  678-685-3265 or mike.collopy@veracitycapital.com.

About Michael

Mike Collopy is wealth advisor and partner at Veracity Capital. As a fiduciary who puts his clients’ interests first, always, Mike is known for providing a holistic perspective on his clients’ finances. His comprehensive process first looks at the big picture of each client’s family, health, and wealth, then drills down to provide solutions for their financial needs, concerns, and goals. He’s passionate about the science of financial planning and investing and uses that to help his clients build a strong foundation for their financial life. Mike serves career-driven individuals who need professional advice to manage their wealth and maximize their opportunities, such as corporate benefits and complicated compensation packages. He considers his clients to be like family, and strives to support them and their families as they work hard for their financial future. 

Mike has a bachelor’s degree in finance from Coastal Carolina University and an MBA from The College of Saint Rose. He is also a CERTIFIED FINANCIAL PLANNER™ practitioner and a Certified Investment Management Analyst®. When he’s not working, you can find Mike spending time with his wife and young son, often exploring the great outdoors by hiking or enjoying the beach. He likes to stay active, playing basketball and training for half marathons. Mike gives back to the community by supporting organizations dedicated to finding treatments for cystic fibrosis. To learn more about Mike, connect with him on LinkedIn.

Advisory services offered through Veracity Capital, LLC, a registered investment advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.