By Antonio Porretta
High-income earners have unique challenges when it comes to saving for retirement. One solution is a deferred compensation plan, a retirement plan typically offered through an employer. This tends to be a popular option because it can save professionals a lot of money not only into retirement, but during the working years as well. When using a deferred compensation plan, the professional can defer a portion of their income to the plan where it can grow tax-free.
Any opportunity to avoid taxing your income sounds good, right? But like most things, there are pros and cons. While there are some great advantages of deferred compensation plans, there are also some drawbacks to consider. Let’s discuss the positives and negatives of deferred compensation plans before deciding if this is the best option 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 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. 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 70½. 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.
We’re Here for You
Understanding all the specifics of deferred compensation plans is not always easy, but having a wealth manager who can help you work toward your end goal is crucial. At Blackbridge Financial, we partner with our clients to help solve their retirement planning challenges. We understand that your financial and retirement plans are long-term, and we are committed to working with you throughout your financial journey. Because of our extensive experience working with clients, we know what to look for and what types of strategies will help to safeguard your wealth management plan from risks associated with a deferred compensation plan.
To learn more about our unique approach to financial planning and see if we’d be a good fit to work together, email me at email@example.com or call 704.960.9646.
Antonio Porretta is an independent wealth manager at Blackbridge Financial with over 20 years of experience. He specializes in helping people create, distribute, and preserve their wealth. Antonio received an executive MBA from Saunders College of Business at Rochester Institute of Technology in 2007 and also holds the Accredited Asset Management Specialist℠, AAMS® designation. Originally from Rochester, NY, Antonio has been a resident of Harrisburg, NC, since 2007. Outside of work, he enjoys playing soccer and tennis, coaching, and spending time with his wife, Laura, and their children, Cristiano, Victoria, and Matteo. To learn more about Antonio and how he can make a difference in your financial life, visit www.blackbridgefinancial.com.
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