Save for Retirement: Deferred Compensation Plan

A nonqualified deferred compensation (NQDC) plan can help you save for the future. It is useful for goals like retirement. Plus, it offers tax benefits. However, to maximize its potential, careful planning—often years in advance—is essential.

Two key considerations for NQDC plans are determining how to fund them and selecting appropriate investment options. Start by deciding whether to defer a portion of your salary, bonuses, or other compensation. Then, align your investment choices with your broader financial portfolio while adhering to the specific rules governing NQDC plans.

Making Deferral Elections

When offered an NQDC plan, you usually have a limited window—often 30 days—to enroll. Depending on the plan's terms, you may defer portions of your salary, bonuses, or long-term incentive payments. If the plan permits preretirement distributions, you’ll also need to specify when you want to begin receiving funds.

Because your deferral elections typically lock in for the year, thoughtful preparation is crucial. Consider these factors:

●      Your income outlook: If you have a steady salary, an “evergreen” deferral option that renews each year may work for you. For fluctuating income, adjusting deferral amounts yearly can be advantageous.

●      Tax implications: You do not pay taxes on deferred compensation until you take distributions. This can help you avoid higher tax brackets when you earn more. However, FICA taxes are due when income is deferred.

●      Deferral period: Decide how long to delay the income. This could be for retirement or a shorter goal, like paying for a child's college.

●      Re-deferral options: See if your plan lets you change your deferral schedule in the future. Also, check the timelines for these changes.

●      Investment allocations: Split deferred amounts to match different goals. For example, use 70% for retirement and 30% for short-term needs.

Investing in an NQDC Plan

Unlike traditional investments, money in an NQDC plan is not directly invested. Instead, it is linked to “notional” investments for accounting reasons. Your employer essentially promises to pay deferred amounts later, with returns mimicking those of chosen benchmarks like stock indexes or mutual funds.

To align your NQDC investment strategy with your financial goals:

●      Time horizon: If distributions are decades away, growth-oriented benchmarks may be appropriate. For shorter-term goals, consider more stable options.

●      Diversification: Use the NQDC plan to enhance your overall portfolio diversification, potentially accessing unique investment options not available elsewhere.

●      Risk tolerance: Assess how much risk you’re comfortable taking with deferred funds. Evaluate historical performance of different investment allocations to guide your choices.

It's important to remember that NQDC plans come with unique risks, such as exposure to company solvency. If you’re concerned about your employer’s financial health, consider shorter deferral periods or limiting the amount you contribute.

Bottom Line

Finally, NQDC plans often offer a wide range of investment choices. With many options available, it is a good idea to focus on diversification.

Work with your financial advisor. This will help ensure your NQDC plan matches your overall strategy and risk tolerance. By understanding how to fund and invest in your NQDC plan, you can leverage it as a powerful tool for achieving long-term financial success.

Sources:

https://www.fidelity.com/viewpoints/retirement/nqdc-part-2

Disclosures:

This information is an overview and should not be considered as specific guidance or recommendations for any individual or business.

This material is provided as a courtesy and for educational purposes only.

These are the views of the author, not the named Representative or Advisory Services Network, LLC, and should not be construed as investment advice. Neither the named Representative nor Advisory Services Network, LLC gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. Please consult your Financial Advisor for further information.