There are obviously many retirement vehicles you, as a corporate executive, have considered, but have you overlooked the option of the company-sponsored non-qualified deferred compensation plan?
Significant wealth may be created in NQDC plans, where assets have the opportunity to compound tax-free and investment options are frequently attractive. Two times a year, corporate executives are offered the option of deferring a portion of their compensation in order to put away money for their retirement in these plans. Quickly approaching is the June 30 deadline for deferring variable or incentive compensation for this year.
Basic modeling shows that assets invested inside a deferred compensation plan for 10 years would grow 1.75 percent more annually than the same amount invested for the same period receiving identical returns.
Is an NQDC the right choice for you?
While those returns are real money, it is important to remember there are, of course, risks associated with investing, as well as eventual tax payments. As such, there are six questions that can help you determine whether deferring compensation is a good choice ahead of the upcoming June 30 deadline:
- Do I have sufficient liquidity? It may be beneficial for you to borrow — just so you can put more into the deferred compensation plan — given the growth potential of tax-free compounding and today's low interest rates.
- How long can I afford to defer? The longer you are able to defer, the more cushion you have against rising rates.
- What investment options are available to me in the plan? Review the options with your financial planning team to think through if your plan's investment offerings are compelling.
- Does my company offer a matching contribution? If so, how much would that potentially increase my final return?
- Where do I plan to live when I retire? If you work or reside in a state that levies its own income tax, the benefit of deferring taxation is further enhanced. If you were to later move to a state with a lower income tax or no tax at all, you would realize additional, significant savings as long as the distribution is ultimately taken in 10 or more installments.
- Am I comfortable with my company's credit risk? If your company goes bankrupt, you are merely one of its general creditors.
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While asking these questions of yourself, it is important to consider the impact of deferring. For example, it is usually best to defer for at least seven years to take full advantage of tax-deferred growth. While there are no federal limits to contributions to NQDC plans generally, a company's particular plan may impose certain limits on the amount you can defer, either each year or as an aggregate over multiple years.
If you have reviewed the questions and considered all the risks and rewards, you still have time to defer. Your company will likely notify you about the upcoming election and supply the correct paperwork.
When filling out the forms, you will be able to choose the options that best suit your needs. This includes whether you want the compensation (when you do receive it at a later date) as a lump sum or in annual installments, as well as when you want to receive the deferred income: in a specific year, upon a specific event such as retirement or after a number of years of deferral.
Some plans also offer the opportunity to re-defer compensation so long as certain criteria are met. In this circumstance, you can not only alter the timing of your distribution(s), but also the mode of distribution (lump sum versus installments). In addition to confirming that your company's plan allows for re-deferral, carefully consider three other key requirements:
- Re-deferral elections can only be made if at least 12 months have passed since you made the original election.
- You can only re-defer compensation if the new distribution will take place at least five years later than the distribution was originally scheduled to occur.
- Re-deferral elections are only possible if the distribution is currently scheduled to take place more than a year from the current date.
Are you worried about missing the deadline? Never fear: If an executive is not ready ahead of June 30, December 31 is the deadline for deferring fixed compensation (or a combination of performance and fixed compensation) for the following year, making now a good time to consider all available plans and options.
— By Robert Barbetti , head of executive compensation advisory at JP Morgan Private Bank