Questions Executives Should Ask Their Financial Advisor About Deferred Compensation Part I

Congratulations! You’re an executive and you now qualify for deferred compensation plans. But what does that mean?

You might have heard the term “deferred compensation plan” before. If not, you might be more familiar with the idea than the term, so this definition might ring some bells when you put it in context: A deferred compensation plan is one in which a portion of an employee's pay is held until a specified date, usually (though not always) retirement.

A deferred compensation plan:

• Can help highly-paid executives plan for retirement or the future by providing options beyond basic plans like a 401(k).

• Gives executives the option to put funds into a special, separate account, not a paycheck, making it so taxes are also deferred.

• Allows executives to choose when to take the compensation (for example, upon reaching a certain age, upon retirement, etc.).

A deferred compensation amount may or may not be invested. If investments are involved, they are typically limited but come with options of where the funds are invested.    

Knowing what the term means is great, but that is the tip of the iceberg. When it comes to deferred compensation, there are many questions you should be asking your financial advisor, especially as you are planning long-term.

We put together common questions executives have about deferred compensation plans – questions you should be asking your financial advisor. It’s a complicated topic, though, so we’re splitting this article into two. Let’s get started by examining qualifying plans and non-qualifying plans.

What makes a deferred compensation plan “qualifying”?

You know that there are many types of deferred compensation plans. But what does “qualifying” actually mean? Basically, it means the plan is compliant with ERISA, the Employee Retirement Income Security Act of 1974, a federal law that establishes minimum standards for pension plans in private industry and provides for extensive rules on the federal income tax effects of transactions associated with employee benefit plans. A qualifying deferred compensation plan can include a 401(k), a 457 for state and local government employees, or similar plans. For executives, the key here is to ask your financial advisor what basics you are already getting from participating in a qualified plan.

What makes a deferred compensation plan “non-qualifying”?

As with anything in financial planning, truly understanding a non-qualifying deferred compensation plan (NQDC) requires you to know more than just the terminology. The devil is in the details, and in this case, the details include the way your money is being handled by your employer. With an NQDC, the compensation is assigned to you, but it’s not set aside for you, waiting for your retirement or other designated day of distribution. The NQDC represents a promise. The funds are part of the company’s general assets and would be subject to claim if the company went bankrupt. So, stop right here. Do you understand the risks? If you’re deferring compensation you need to have confidence that the company will be able to pay you later.

If you are living within your means, you are comfortable with the risks and you can afford to take advantage of an NQDC plan, there are other benefits, such as flexibility. Consider what Fidelity says: “NQDC plans aren’t just for retirement savings. Many plans allow you to schedule distributions during the course of your career, not just when you retire, so you can defer compensation to cover shorter-term goals like paying a child’s college tuition. You also can change your deferral amount from year to year.”

When it comes to NQDC plans, you definitely will need to ask your financial advisor about risks and whether or not this kind of plan best suits your comfort level and your strategy.

In Part II, we will go a little further into what you as an executive should be asking your financial advisor about deferred compensation plans. Stay tuned.

Wood Smith Advisors, a woman-owned Registered Investment Advisor (RIA), is a fee-only financial services firm that partners with its clients to simplify their financial lives. We focus on women, entrepreneurs and individuals with complex financial situations, providing objective and competent advice, education and services to help them develop and build their businesses and reach their financial goals. We can be reached by clicking here.

"Finance Made Simple" blog posts are intended for educational purposes and not for specific advice. Each person’s situation is different. Consult your financial advisor for advice relating to topics discussed.