What is it?
Simply put, deferred compensation is agreeing to take income you have earned from an employer at a later date. This can come in the form of a retirement plan, a pension, stock options or other products. Typically the money can be distributed to you as either a lump sum or in periodic payments. Deferred compensation could be an option to consider for your retirement savings, if the fit is right for your situation.
What are the advantages?
Normally, deferring compensation allows you to defer tax payments on that income until you receive the money. Neither your contributions nor your growth get taxed; you are only taxed when you take a distribution. This could help you if you anticipate being in a lower tax bracket later in life. Also, if you defer enough of your income, you could also put yourself in a lower tax bracket now because the total income you receive currently is less.
You might find that deferred compensation is a great way to enforce discipline on your spending and saving. Having a sort of forced savings account via deferred compensation can help you stay focused on creating a nest egg.
If the deferred compensation is issued to you in the form of stock options, there is a chance your money could grow at a rate beyond what an average retirement account could achieve. Of course there is also the risk of a large loss with stock options.
What are the disadvantages?
In recent years, employees of some companies that have declared bankruptcy have lost some or all of their deferred compensation. Be aware that this could be a potential risk for your money.
There is no guarantee that your taxes will be lower when you choose to take your distribution at a later date. For that reason, deferred compensation can be a bit of an educated gamble.
Rules vary by plan, but many of the available deferred compensation choices make it difficult to access your money should you need it in a pre-retirement emergency. For this reason, it shouldn’t be considered a very liquid asset.
Is it right for me?
Deciding whether or not to take advantage of deferred compensation can be a complicated decision. It’s best to consult with a certified financial planner and a tax professional before making any final choice.