Why Settle For A 401 (K)? How Deferred Compensation Can Be A Big Boost

We discuss with Ashley Cline, an associate wealth advisor at JFS Wealth Advisors, based in Hermitage, Pa., how deferred-compensation plans can support long-term wealth-building, reduce tax liabilities and create future income flexibility.

Larry Light: Many people have heard the saying, “Good things come to those who wait.” How does that apply in the world of executive compensation?

Ashley Cline: It’s especially true when it comes to deferred compensation. These plans enable high-earning professionals to defer receiving part of their income, typically bonuses or other forms of compensation until a later date. The real advantage is that taxes are deferred as well, meaning your earnings can grow tax-free until you eventually take the money out, often in retirement.

Light: What kinds of deferred compensation plans are there?

Cline: There are two main types: qualified and non-qualified. Qualified plans include 401(k)s, pensions, and profit-sharing plans. These are governed by the Employee Retirement Income Security Act, or ERISA, which sets rules around contribution limits, asset protection, and eligibility. If you’re already contributing to a 401(k), you’re participating in a qualified deferred-compensation plan.

Whereas, non-qualified plans, on the other hand, are typically designed for executives. They don’t follow ERISA rules, so there’s more flexibility but also more risk. These plans often let you defer significantly more income than a 401(k) allows, which can be a massive benefit for highly compensated individuals.

Light: What are some potential risks or drawbacks with non-qualified plans?

Cline: Unlike qualified plans, the assets in non-qualified plans aren’t required to be held in a separate trust. That means they remain part of the company’s assets and if the company runs into financial trouble, those funds could be at risk. Also, once you choose your withdrawal schedule, it may be hard to change. In some plans, investment options may be limited sometimes to only company stock, which can lead to an overly concentrated portfolio.

Light: What factors should be considered before participating in a non-qualified plan?

Cline: The decision whether to participate should be weighed seriously. These plans can be an excellent tool if you don’t need the money right away, expect to be in a lower tax bracket in retirement, and have confidence in your employer’s long-term health. They can also be ideal if you’ve maxed out your qualified plan contributions, but still want to set aside more for the future or need greater flexibility for the timing and amount of withdrawals.

Light: Any final advice?

Cline: Deferred compensation plans for qualified plans, if offered by your company and you qualify, are almost always a good idea to make regular contributions, preferably to the maximum allowed. Non-qualified plans can be powerful but complex, and it’s important to understand the rules and risks before committing. That’s where working with a financial advisor can help.