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Deferred Compensation Plans 101

January 25, 2017

There are several factors involved in planning and saving for retirement that often leave the average individual feeling overwhelmed. Many of the plans available to choose from are complicated, and thus most people fail to take advantage of the benefits of different plans. With so many different plans available, it is important to understand the basics of how they operate. If not to help yourself make your own decisions, it will allow you to ask informed questions of your financial advisor.


What is Deferred Compensation?

Deferred compensation plans allow you to defer a portion of your salary which you are legally permitted to receive until a later date. You are effectively given an IOU from your employer that acts as a note promising that you will be paid later by your employer. You can decide upon the percentage of your pay that you would like to defer and even select a date at which you will be paid that amount.


It is important to note that varying plans have restrictions on the pay dates you can select in the future. Generally, the money you defer through a deferred compensation plan is placed into an account in your name and invested into a mutual fund or other investment vehicle. Depending upon your company's offered plans, you may or may not get to select those investment vehicles.


Why Should You Do This?

A deferred compensation plan from your employer offers the benefit of forced savings for retirement. It may serve as a powerful tool for retirement savings without you having to decide later whether you will invest that money or not.


Beyond retirement, deferred compensation can be used for a variety of other financial goals. For example, if you are saving money for a down payment on a home or starting a college fund for your child, a deferred compensation plan sets money aside that is owed to you later which may be used to meet these financial challenges as well.


Pitfalls to Watch Out For

Like anything else in life, deferred compensation plans are not a perfect solution to any investing or financial challenges. For starters, no two plans are the same and some employers select plans with severe restrictions on the disbursements you hope to collect in the future. The rate of return paid on a deferred compensation plan may be lower than that of an after-tax account you might otherwise place that money in.


Perhaps the greatest pitfall is the unknown status of the company you work for. Because you are accepting what amounts to an IOU from your employer, if the company falls on hard times they may opt to defer your payment even longer until a financial crisis comes to an end. Similarly, if the company goes out of business, or file Chapter 11 bankruptcy, you may become just another creditor that money is owed to.


Take Your Time, Make a Wise Choice

As with any other financial decision, it is vital that you weigh the pros and cons of placing your income into a deferred compensation plan. Do your homework, not only on the plans offered by your employer, but also on the health of your company in the moment and your industry to ensure you are likely to be paid that money owed to you in the future.

For more information, contact Manhattan Ridge Advisors