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Retired Military Finances 301: Deferred Compensation Thumbnail

Retired Military Finances 301: Deferred Compensation

Retirement Funding

Just as some privileges increased with your rank while on Active Duty, you may see some benefit increases as you rise through the corporate ranks. One option that may become available to you is a deferred compensation plan. So, just what is it?

What is a Deferred Compensation Plan?

Deferred compensation is generally considered a non-qualified plan. Non-qualified plans, if structured properly, exclude income from current taxation. This is generally achieved by placing the plan assets at substantial risk of forfeiture. That could be caused by you not meeting some milestone. Or business performance could put your assets at risk.

In the case of deferred compensation, the substantial risk of forfeiture is tied to business performance. When you contribute funds to a deferred compensation plan, you don't actually contribute money to an account (in most cases). The contributions are entered on the company books as a liability. In essence, you become a lender to the company. And, if the company goes bankrupt you may or may not get you contributions back. Therein lies the substantial risk of forfeiture.

How are Contributions to a Deferred Compensation Plan Taxed?

Contributions to a Deferred Compensation Plan are excluded from income for income tax purposes. Social Security and Medicare (FICA) taxes are paid depending on who made the contribution to the Deferred Compensation Plan. If an employee defers salary or bonuses, FICA taxes are due in the year of deferral. If the employer contributes fund (not salary or bonus) to the Deferred Compensation Plan, FICA taxes are due when the funds vest. From a practical standpoint, the Social Security taxes may be irrelevant as many employees that qualify for deferred compensation earn above the Social Security wage base, but you will pay Medicare taxes on the contributions.

When Can I Get Funds Out of a Deferred Compensation Plan?

This is an "it depends" question. The plan will state when you can get funds out. What won't apply though is the age 59 1/2 rule that applies to most retirement plans as a Deferred Compensation Plan isn't technically a retirement plan. That means a Deferred Compensation Plan can be a great bridge from an early retirement until you can access retirement funds penalty free.

Should I opt in to a Deferred Compensation Plan?

If your earnings are sufficient to cover your living expenses and you've maxed out your retirement plans or you plan on retiring early, deferring can be a good choice. As mentioned, if you're being offered access to a Deferred Compensation Plan you probably make pretty good money and are in a pretty high tax bracket. There is a pretty good chance you'll be in a lower tax bracket early in retirement, so you'll get some tax arbitrage plus you'll get some tax-deferred growth while the assets are in the Deferred Compensation Plan. And as mentioned earlier, a Deferred Compensation Plan can help fund an early retirement.

Military Finances are Different

I think I remember hearing once that a military pension was deferred compensation for prior service. I suppose you could think of it that way. But it really isn't. And in fact, there are a lot of things related to finances that are different for Active and Retired Senior Military Officers and NCOs than for a civilian. That's why we think you should work with a financial planner or advisor that deals with your unique situation each and every day. If you'd like to find out how we work with clients like you, use the button below to schedule a free initial consultation.

If you found this article useful, you might like the following blog posts:

Retired Military Finances 201: 457 Plans. Not Like the Others.


Retired Military Finances 401: Restricted Stock and the 83(b) Election


Retired Military Finances 401: Phantom Stock. No it Doesn't Have Anything to Do with the F-4



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