Are you making more money this year than usual? Worried about the big chunk that will go to taxes? Fear not. You may have an option that lets you reduce your taxes, save money for the future, and compound your savings tax-free. It’s called deferred compensation. Most people who work for a company and anyone who has their own company can defer compensation and reap big benefits. Read on…
Defer, delay and compound
Deferred compensation has been around for decades. I first deferred pay in 1985, and you can still do it in 2017. Why don’t more people know about it? Usually, it is because the typical public company employee doesn’t have time to investigate pay delay, or the company doesn’t preach about it. Private company key employees and owners might not have the time to set up a plan. Our advice is to educate yourself about your deferred compensation choices and see if it makes sense for you.
How it works
The IRS allows you to defer some of your compensation until future years. When you defer you 1) reduce your current taxable income 2) reduce this year’s taxes 3) delay payment of tax on that money until a later year (when your tax rate may be lower), and 4) create savings that compound without current taxes.
Think of deferred pay as a type of IRA with much higher contribution levels. I have handled deferrals and their investments in amounts of five, six and seven digits. A typical deferral is ten years. Some go as long as 35 years (mine included).
Talk to your accountant and your advisor
Because tax rules are strict, I don’t recommend it as a do-it-yourself project. Be sure to consult your accountant so he/she understands your intentions and goals. Talk to your advisor about investment options. Some companies restrict the investment options. More typically, the choice of allowed investments is diverse.
For those who like to read the tax code, Section 409a, Non-Qualified Deferred Compensation describes the rules for delaying your pay.
Windfall deferral or super deferral kicks in when you get a lot of compensation in one year. You might have had a big compensation increase because of a new position. Or, in the case of a private company you may have had a great year, with a lot of revenue and profits pouring in. It’s a good problem to have.
Client Ken, for example, had a windfall year in 2016 and was able to defer $250k, reducing his current taxes by $100k. Ken is a saver and net investor. The $250k has been at work in a diversified portfolio this year. Ken will defer additional money in 2017 because his windfall deferral plan requires 5 years of contributions. Great savings!
If you work for a public or private company, ask HR about deferred compensation: who qualifies, how much, when, and so on. This question is a routine inquiry.
If you have your own company, talk to your accountant about setting up a deferral plan. The choices are wider and bigger for company owners. There is no one right way for everyone.
If you would like advice on deferred compensation, call or email us. We’ve done deferrals for others and for ourselves. You can do it, too.
You may enjoy reading this article on Your Financial Cushion because it also discusses savings.
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