Should You Use a Non-Qualified Deferred-compensation Plan For Your Retirement Savings?

Have you ever been offered a non-qualified deferred compensation plan as part of your benefits package? Do you know someone who has, but wasn’t sure exactly what it was?

Don’t miss out on this important piece of financial education that could affect your pay structure.

What is a non-qualified deferred compensation plan and who is it for?

Not every employer offers a non-qualified deferred compensation plan. When it is offered it is often used as a recruiting or retention tool by the employer and is generally extended only to select employees. These types of plans are often made available to executives to give them opportunities to save additional money in tax-deferred accounts.

High-income earners may feel restricted by the financial limitations of 401K plans. While 401Ks are limited to $20,500 per year, a deferred compensation plan has no limitations. You shouldn’t use a deferred comp plan to replace your 401K; rather, a deferred compensation plan provides another way to save tax-deferred earnings. These plans are optimal for high earners who foresee themselves in a lower tax bracket in the future.

The pros and cons of deferred compensation plans

The funds that one contributes to the deferred compensation plan are tax-deferred–only upon withdrawal will the funds be taxable. These plans allow you to save and grow your money while deferring the taxes to a later date. Another benefit is that the funds in your deferred compensation plan aren’t subject to RMDs. Taking advantage of a non-qualified deferred compensation plan can help you reduce your lifetime tax rate.

The payout of these plans varies by company and plan which is why it is extremely important to read the fine print before signing up. The payout may be predetermined by year, or it could end in a pension-type arrangement, or in a lump sum. While there may be choices in the final payout up front there may not be any flexibility to change it later so it is essential to understand the details when you sign up. Not everything is roses with deferred comp plans, so make sure to listen in to hear the drawbacks to non-qualified deferred compensation plans so that you can find out how you can protect yourself and your assets.

If you are working with an advisor and have been offered a non-qualified deferred compensation plan, make sure to run through various scenarios with them. If you don’t have a financial advisor, reach out to us to see if we can help you make the best decision for your situation.

Related: When Retirement Is Derailed by a Terminal Illness