Deferred compensation plans such as Qualcomm’s can be great tax planning vehicles, but they can be more complex than they appear. Hidden risks, avoidable mistakes, and tax consequences might not be immediately obvious. Some executives have faced unexpected losses negating the income tax benefits. With proper planning, many of these can be avoided. Sometimes, the damage is already done. In those cases, there are still some tools we can use to learn from those difficult situations.
Deferred compensation is a benefit provided to high-level executives, allowing them to defer, save, and invest their pay. Executives can choose how much to save each year, how to invest those savings, and when to receive the funds, typically after leaving the company. These savings are not taxed immediately but are taxed when paid out in the future, which can be done as a lump sum or over several years.
Deciding whether to save into a deferred compensation plan depends on various factors such as tax rates, financial needs, company stability, investment options, and employer contributions. Here at Stratos Private Wealth we help clients understand these complexities and create a savings strategy that aligns with their goals. This involves evaluating other savings vehicles like 401(k) plans or taking advantage of tax-efficient strategies like Employee Stock Purchase Plan (ESPP) arbitrage or Health Savings Accounts. In other words, it’s important to understand the overall amount you can save in a year and then direct money to the best accounts first.
Once a savings plan is established, choosing how to receive deferred compensation payments is crucial. Lump sum payments may be taxed heavily, especially if they are received while still working. Spreading payments over time and understanding your expected tax rate in the future is critical to planning a payout strategy. To do this, we consider other income sources, expenses, and tax rates in the future.
Some payouts cannot be modified after they are established. Some may be modified with limits. For example, Qualcomm’s plan allows for some DC payments to be extended, as long as you elect to make the change more than a year before the payout is set to begin. Pre-2015 contributions generally are not able to be modified. Payouts may have other implications, as well. For example, some of our clients are considering moving out of CA in retirement to a lower tax state. Specific planning for Deferred Comp payments can preserve the ability for those folks to avoid CA income taxes, if done correctly.
Longer payout arrangements must be carefully weighed against other considerations. For example, spreading out payments over 10 years may keep income taxes low. However, this may push payments into years which overlap with Social Security or Required Minimum IRA distributions. Additionally, one key risk, forfeiture in the event of your employer’s bankruptcy, is often a strong incentive to avoid lengthy payout periods. We help our clients craft the best payout plan that fits their specific situation.
Investing deferred compensation funds follows a similar approach to other retirement accounts, considering factors like financial needs, time horizon, and risk tolerance. While Stratos Private Wealth does not manage these accounts directly, we provide our clients with specific investment recommendations for their deferred comp plans as part of our service. Oftentimes, the time horizon or investment objectives for deferred comp are different than those for a client’s other investments. We take that into account and can create different recommended portfolios for different deferred comp payouts.
Here at SPW, we can help you navigate your overall finances in a way that simplifies your life. Your deferred compensation package is just one aspect of that financial life, which involves taxes, estate issues, retirement planning, and other considerations. If you need help putting everything together, we’re here to help. Our advisors can assist you with deciding how much to save, where deferred comp fits in the optimal savings order, how to invest the funds, and how to structure the payouts. A thoughtful strategy can help maximize your after-tax money, balance various risks, and fuel your retirement.
Disclosures:
Stratos Private Wealth is a division through which Stratos Wealth Partners, Ltd. markets wealth management services. Investment advisory services offered through Stratos Wealth Partners, Ltd., a registered investment adviser. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stratos Wealth Partners and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction