Let’s say you’re a high-earning professional—perhaps a tech executive, entrepreneur or key leader—approaching a pivotal financial milestone. Between salary, performance bonuses and equity compensation, it can feel like both a reward and a challenge. You may ask yourself: How can I manage my tax burden while planning for long-term financial security?
Take this example: A tech executive faces a hefty year-end bonus and significant proceeds from exercising incentive stock options (ISOs). This creates both financial opportunities and tax complications. By utilizing a deferred compensation plan (DCP), it can smooth income across multiple years, minimize taxes and create a dependable cash flow for retirement—all while aligning compensation with long-term financial goals.
Deferred compensation plans, including non-qualified deferred compensation (NQDC) options, are powerful tools for executives and key employees. They can be used on a standalone basis or paired opportunistically with other forms of equity compensation, such as restricted stock units (RSUs) and ISOs, to create an executive compensation strategy.
What is deferred compensation?
A deferred compensation plan allows you to delay receiving a portion of your income until a later date—often retirement or another future milestone. This strategy can reduce your taxable income today while enhancing long-term savings.
But deferred compensation is more than just a tax strategy—it’s a powerful way to take control of your financial future. By balancing income now with future financial goals, you can optimize your cash flow, plan for retirement and align your earnings with tax-efficient wealth strategy. However, these plans are not a one-size-fits-all solution. Your specific circumstances, employer plan structure and financial goals all play a role in determining if a deferred compensation plan is right for you.
Deferred compensation vs. 401(k): How they compare
One of the most common questions executives ask is how deferred compensation compares to a 401(k). While both offer tax deferral benefits, they differ in important ways:
Unsecured—dependent on employer’s financial health at the time of distribution
Portability
Can roll over to IRA or new employer plan
Cannot be rolled into tax-advantaged accounts
Flexibility in Plan Design
Limited to standard rules
Plan features are determined by the employer and can vary significantly between plans.
For executives who have maxed out their 401(k), NQDC plans offer an opportunity to defer additional income while managing tax exposure.
Two main types of deferred compensation plans
Qualified plans: These include 401(k) plans, which are protected under the Employment Retirement Income Security Act (ERISA). They offer tax deferral benefits but come with contribution limits and regulatory restrictions and protections.
NQDC plans: More flexible, these plans are designed for a select group of employees and allow higher deferrals and customized (within employer-set limits) payout structures. However, NQDC plans are unsecured and dependent on your employer’s financial stability.
Salary deferral plans: You can defer a percentage of your base salary or bonus.
Supplemental Executive Retirement Plans (SERPs): Employer-funded plans designed to supplement retirement income.
Deferred Restricted Stock Unit (RSU) Plans: Allows you to defer the receipt of vesting RSUs, postponing taxation while aligning your equity compensation with long-term financial goals. This can be an especially useful strategy for executives who are subject to minimum shareholding requirements.
Key comparison:
Pros of NQDC Plans:
Cons of NQDC Plans:
No IRS contribution limits.
Flexible design options.
Can smooth income across multiple years to optimize tax efficiency.
Deferred RSU plans offer additional flexibility for executives managing large equity payouts.
Funds are unsecured and at risk if the employer becomes insolvent.
Limited portability—NQDC funds can’t be rolled into IRAs or 401(k)s.
Requires careful timing and planning to minimize tax liability.
Some plans require deferred funds to be invested in the employer’s stock, amplifying the participants’ concentration risk.
Remember, the benefits and risks of NQDC plans vary depending on your employer’s plan structure and financial health. Consulting with a financial advisor can help determine if this approach is right for you.
How Deferred Compensation Aligns with Equity Compensation
Deferred compensation also works in harmony with equity compensation planning, helping executives align income with tax-efficient strategies. For example, Deferred RSU Plans provide a way to control the timing of taxation on vesting stock units, allowing executives to integrate stock-based income with broader deferred compensation strategies.
Now that we’ve covered what deferred compensation is, let’s explore who stands to benefit the most from these plans.
Who should consider deferred compensation?
Deferred compensation can be a game-changer for individuals facing unique financial complexities, such as:
Tech executives balancing equity payouts with taxable income.
Entrepreneurs using deferred income to smooth variable cash flow.
C-suite leaders looking to diversify income streams and reduce exposure to the tax consequences of year-end bonuses.
Not all high earners will benefit equally from deferred compensation. It’s essential to assess your situation and goals with a trusted financial advisor to determine if this strategy fits into your broader financial plan.
Benefits of deferred compensation plans
Tax savings and income smoothing:
Deferred compensation is often used as a tax strategy for high earners to reduce their immediate tax burden. However, it’s important to structure distributions properly to optimize tax treatment.
Under IRS rules, if deferred compensation plan payouts are set up to occur in substantially equal amounts over 10 years or longer, they will be taxed in your state of residence at the time of distribution. This can be beneficial for individuals planning to relocate to a lower-tax state in retirement or those anticipating lower-income years in the future.
Because state tax treatment is tied to IRS regulations, it’s essential to structure your deferral elections carefully. We recommend discussing these considerations with your tax and financial advisors to ensure alignment with your overall financial strategy.
Enhanced retirement savings: Deferred compensation provides an opportunity to save beyond 401(k) contribution limits, making it an effective tool for executives who have maxed out other tax-advantaged retirement accounts.
Financial flexibility: Align distributions with retirement or other key financial goals. For example, deferred compensation can be structured to provide income during retirement, help cover college education expenses or support other major life events, such as a home purchase or philanthropic giving. With thoughtful planning, distributions can be structured to align with your cash flow needs while optimizing tax efficiency.
Executive-specific advantages: Helps mitigate high tax liabilities from performance-based bonuses.
If you anticipate retiring in a state with lower taxes or stepping down during a low-income year, deferring compensation may help lower your overall tax burden over time.
Deferred comp risks and considerations
While deferred compensation plans offer significant benefits, they also come with risks that require careful planning. For example, your NQDC funds are dependent on your employer’s financial stability, which makes diversifying your assets a crucial part of your overall strategy.
Employer solvency: Your NQDC plan is unsecured and tied to your employer’s financial health. If your company faces financial difficulties during the years you’re due to receive plan payouts, your deferred compensation may be at risk.
Deferred comp portability issues: Unlike 401(k)s, your NQDC funds can’t be rolled into IRAs or other tax-advantaged accounts if you change jobs. However, this does not mean you forfeit the balance—your employer is still obligated to pay out the deferred comp according to the plan’s terms.
Planning for deferred comp payouts during career transitions
Many executives structure their NQDC payout date as “at separation,” meaning distributions begin upon leaving the company. Because payout options are determined at the time of deferral, it’s important to consider how a future job change or retirement may affect your cash flow and tax situation.
Since NQDC plans lack the portability of traditional retirement accounts, long-term career and financial planning should be factored into your deferral elections. We recommend working with a wealth manager to structure payouts in a way that aligns with your broader financial strategy.
State tax implications
Your deferred income is generally taxed in your state of residence at the time of distribution, following IRS rules. If you relocate to another state after deferring funds, IRS regulations will determine which state has the right to tax your deferred compensation benefits.
If NQDC payouts are structured as substantially equal payments over 10 years or more, they are typically taxed where you live when received—not where the income was earned. Otherwise, they’ll be taxable in the state in which you resided when you deferred the income.
Deferred comp distribution rules
Your deferral elections must be made in the calendar year before the income is earned, and federal rules limit your ability to modify payout dates once elections are set. This means your compensation strategy requires careful planning to align deferral decisions with your future financial needs.
These risks highlight the importance of integrating deferred compensation into a broader financial strategy, ideally with professional guidance from your tax advisor and wealth manager.
Understanding the benefits and risks of deferred compensation is just the start. To make the most of this powerful tool, a thoughtful strategy is key.
Strategic planning tips
Deferred compensation should provide peace of mind, not stress. Here are some considerations on how to structure your plan effectively:
Maximize employer matching contributions: Some companies match a portion of the income an executive defers in a given year. If your employer offers a match, consider deferring at least that amount to take full advantage of the benefit.
Integrate it into your financial plan: Think beyond the NQDC plan by diversifying assets both inside and outside the plan to reduce reliance on one source of funds and improve overall financial flexibility. Ideally, your deferred compensation balance should be invested in a diversified portfolio (rather than company stock) to complement your broader investment strategy.
Optimize timing: Plan your deferrals and distributions to align with anticipated lower-tax years, helping to smooth your cash flow over time.
Evaluate tax-efficient savings options: HSAs, retirement accounts and NQDC plans each have distinct benefits that should be considered in the context of your broader financial picture.
Manage exposure to employer stock: Deferred compensation should be carefully structured alongside your equity holdings to manage concentration risk and maintain a balanced investment approach.
Each of these strategies requires careful tailoring to your circumstances. We recommend working with a financial advisor to personalize these approaches based on your specific needs.
Deferred compensation can be a valuable tool for executives navigating major financial events, such as stock option exercises, liquidity events and career transitions. Thoughtful planning can provide financial flexibility while managing tax burdens associated with these events.
Consider these examples:
Indirect deferral of stock option exercise proceeds: An executive anticipating a stock option exercise in the following year elected to defer salary and bonus into their NQDC plan and replace those funds with proceeds from the option exercise. This approach allowed them to manage their taxable income efficiently while maintaining cash flow.
Using a deferred RSU plan to meet stock holding requirements: Where a company offers a deferred RSU plan, an executive elected to defer a portion of an RSU grant to meet their stock holding requirement over several years. Since taxes aren’t paid on the deferred shares, the holdings accumulate more efficiently than if taxed at vesting, allowing for potentially greater long-term growth.
Relocating to a state with lower tax rate: An executive moving to a state with lower tax rates elected to defer compensation ahead of the transition. By structuring NQDC payouts to occur over 10 years or longer, they ensured their deferred income would be taxed in their new state of residence rather than the state where it was earned. This strategy helped manage income recognition and potentially reduce overall tax liability.
Bridging the gap after retirement: An executive retiring early structured their NQDC distributions strategically, shifting income from high-tax years to lower-tax years while ensuring a steady cash flow until they became eligible for Social Security and other retirement benefits.
These scenarios are illustrative and based on hypothetical examples. Your circumstances and results may differ, so we encourage seeking personalized advice for your specific needs.
At Aspiriant, we specialize in helping clients navigate complex scenarios like these, ensuring their financial strategies are tailored to your unique situations. By aligning timing, structure and cash flow needs, we can help minimize risk and maximize after-tax benefits.
Frequently asked questions
Can I lose my deferred compensation if my company goes bankrupt?
Yes, your NQDC funds are unsecured and could be at risk if your employer is insolvent. Unlike qualified retirement plans, NQDC assets remain part of your employer’s balance sheet, meaning creditors may have access to them in the event of bankruptcy.
How does deferred compensation interact with other retirement plans?
Deferred compensation can supplement your 401(k) plans and other tax-advantaged accounts, but it should be integrated into your overall financial strategy. Because NQDC funds lack the protections and portability of qualified retirement plans, working with a financial advisor can help ensure your deferred compensation aligns with your broader wealth plan.
What are the withdrawal rules for deferred comp?
Withdrawals from your deferred compensation plan are typically restricted to pre-set distribution schedules, limiting flexibility. However, IRS rules allow you to adjust your scheduled distributions, though mostly to push them further into the future rather than accelerate them. Additionally, you must make deferral elections in the calendar year before the income is earned, so planning ahead is essential.
How does deferred compensation affect golden parachute payments during mergers?
Proper structuring can help prevent your deferred compensation from triggering excise taxes under Internal Revenue Code (IRC) Section 280G, which governs golden parachute payments. If your NQDC balance becomes payable due to a change in control, you may be subject to an additional 20% excise tax, and your employer could lose key tax deductions. Careful planning can help you mitigate the impact of 280G rules.
Aspiriant can help you build an integrated strategy
At Aspiriant, we know that your financial future and goals are personal—and so is the way you manage your income and wealth. Deferred compensation is just one piece of the puzzle, and we’re here to help you fit it into your broader financial strategy in a way that aligns with your long-term goals.
Every financial journey is unique, and what works for someone else may not be the right fit for you. Let’s explore whether deferred compensation makes sense for your needs and how we can optimize it as part of your bigger financial picture.
We’d love to help you craft a strategy that gives you clarity, confidence and control. Ready to start the conversation? Connect with an Aspiriant wealth manager today.
Mike Fitzhugh
Director in Wealth Management, Partner
Mike has been delivering comprehensive planning services to high net-worth families since 1983. He served on the Aspiriant Board of Directors, including serving as Chairman from 2007 until 2010.
Mike began his professional career at Deloitte Haskins & Sells in 1982, and joined the Executive Financial Counseling Group, led by Tim Kochis, three years later. For the next five years, he provided comprehensive financial, tax, and investment services to senior corporate executives and other high net-worth families.
After earning an MBA, Mike led the financial planning practice at an investment management consulting firm in Silicon Valley for four years, developing an expertise in the strategic role of stock options in wealth planning. In 1996, he joined Kochis Fitz, the predecessor firm to Aspiriant, and became a Principal of the firm in 1998. During that time, he developed a specialty in designing Rule 10(b)5-1 stock sales plans.
In 2008, Barron’s recognized Mike as one of the 100 top independent wealth managers in America. He has been ranked by the San Francisco Business Times among the top 25 independent Wealth Managers in the Bay Area since that list was developed in 2007. Mike co-authored the book, Wealth Management, A Concise Guide to Financial Planning and Investment Management for Wealthy Clients. As an expert in comprehensive wealth management, he has appeared on National Public Radio’s Marketplace and been quoted in the New York Times, San Francisco Chronicle, San Jose Mercury News, Financial Times, and Research.
Mike has been an instructor in the Personal Financial Planning Program at University of California-Berkeley, and makes presentations at professional conferences for financial advisors, attorneys, and CPAs.
Mike graduated from the University of Arizona with a BS degree in Economics and Finance (with Highest Honors). He earned a MBA from the Haas School of Business at the University of California-Berkeley.
Nick joined Aspiriant at the end of 2014 as an associate in Investment Operations. He transitioned to the Wealth Management team in the beginning of 2017. He has over ten years of experience working in financial services, including seven years working with high-net-worth individuals and families.
Prior to joining the firm, Nick spent time at an M&A consulting firm in San Diego and third-party marketing firm in Orange County, Calif.
Nick earned a B.A. degree in economics and a Minor in accounting from the University of California at San Diego. He earned his CFP® certification in 2017.
Nick lives in San Francisco with his wife. In their free time they enjoy getting outdoors and spending time with friends and family. You can trust that they’ll have recently had an Italian meal, and that Nick has eaten a chocolate chip cookie recently.
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