Is Deferred Compensation a Better Way to Build Assets?
Forty-three and single, Lynn was just promoted to Chief Marketing Officer-Pacific Region. Her higher compensation qualifies her to participate in the company’s nonqualified deferred compensation plan (NQDC). Unlike qualified plans such as 401(k), NQDC plans are highly discriminating in favor of highly compensated executives.
Benefits of NQDC
Deferred compensation offers attractive financial planning benefits to executives such as Lynn. Having an end of year election deadline, in her case, for next year Lynn can defer up to 25% of salary and up to 100% of bonus each year. The contributed amounts represent essentially an unsecured promise by the company to pay a stated dollar amount in the future. Lynn has the opportunity to defer taxable income in a future year, plus earn tax-deferred growth of contributed amounts, until such time as the funds are paid out.
Enrollment and Election
To participate in the NQDC plan, Lynn will enroll and elect either to defer a portion of next year’s compensation to a future year or to receive it when earned. She’ll also elect to receive her eventual benefit in annual installments or a lump sum payment. (This election, although is typically made only one time, depending on the plan may be made annually; however, if she chooses annual installments, she cannot change to lump sum in future years).
Lynn’s plan is designed to provide for distributions in case of voluntary termination or retirement, as well as in-service distributions.
Lynn’s Election Decision
Lynn met with her SFG financial advisor to address these questions and make decisions in her NQDC plan:
- How should she allocate her annual savings among qualified 401(k), taxable savings and nonqualified deferred compensation?
- Would she be better off electing for lump sum or installment distributions?
- How does NQDC fit in with her other forms of stock-based compensation?
- What assurances can the company make that the nonqualified assets will be available when she needs them?
Lynn reviewed with her financial advisor the level of her higher compensation and an indication of her savings target:
Total Savings Target: $85,000
Together they decided Lynn would fully fund her 401(k) contribution ($18,000, indexed), contribute to savings ($12,000), and defer 50% of her bonus ($55,000) to NQDC next year, and will review the election each year.
At SFG Wealth Planning Services, Inc., we can develop a plan to make the most of your executive compensation, including the annual election for your nonqualified deferred compensation. We draw from our training in financial planning, executive compensation and investments. We would be happy to discuss the particulars of NQDC if you give us a call.
*The name, likeness, and circumstances in this example are a fictional composite of facts from executives similar to actual SFG Clients.