Deferred Compensation Plan

If you wish to save and invest your hard-earned money for retirements, there are many ways this can be done with tax benefits. Deferred compensations are arrangements in which a certain amount of the employee's income is paid out at a later date. Some of the most common examples of deferred compensation plans include employee stocks, pensions, and retirement plans.

The contributions you make are for the exclusive benefit of you and your family. The value of your contributions is based on the performance of the investment over time. The 457 deferred compensation plan is designed to supplement your retirement income as your state pension will unlikely be enough to maintain your desired standard of living.


Any pre-tax payments you make will reduce your total taxable income for the year. These contributions are not subject to tax unless you choose to withdraw them. If you would like to start contributing to your 457 deferred compensation plan, contact your employer for instructions. It's important to note that only you can control how your account is invested once you've reviewed all the options laid out by your employer.

A typical deferred compensation plan can include stable value funds as well as the high-risk bonds and stock funds. If you want to build a portfolio of various funds, just opt for a simple target-risk fund. Deferred compensation plans typically don't require minimum distributions, but based on your plan options, you may go for one or two ways to receive your payment: either as a lump sum or in installments. There are advantages and disadvantages to each option, so make sure you take these notes into account.

Lump sum payments

If you choose this distribution, you can get instant access to all your deferred compensation upon retirement. This is a good choice for people who wish to leave their current employer and take control of their investment. Once you receive your payment, you are free to reinvest it how you see fit. However, you should know that you'll be liable for income tax on the entire lump sum. This can result in facing a large tax bill and losing your tax-deferred benefit when withdrawing all the money from the plan.

Installment distributions

With installment plans, you have the option of taking smaller portions on a monthly, quarterly, or yearly schedule. The rest of your deferred compensation will then continue to grow. By spacing distributions over a couple of years, you can help reduce your tax liability, especially if your personal income tax rate goes down. Another advantage is the special state tax benefit that you are entitled to when your payments are made over a period of 10 years or more. The way the payments are structured work on the basis of your actual residence, not where you earned the income. This tax benefit is ideal for those who are planning to move from one town to another. You must therefore plan your distributions carefully around your other income sources in order to meet your cash-flow needs.

Whichever form of payment you choose, make sure you take into account the timing of your distributions as well as income from other plans. It's always best to speak with an independent financial consultant before making any such decisions.

Tax-efficient strategies

You should keep in mind that there is always the potential that your earnings may affect your tax rate. Where you live can also make a difference in how you schedule your distributions as some areas of the country may have higher or lower income tax rates. But no matter which strategy you choose, it's quite difficult to modify the plan once you've created it. In the event of financial problems, disability, or even death, the deferred compensation cannot be paid a year or two earlier than the scheduled distribution date.

It is possible to delay a distribution before the planned date by making a request at least one year in advance. For instance, say you scheduled a distribution for June 2020 to help pay for a new car. Then you decide that you would rather put this money toward retirement. You must make the change before June 2019, and you won't receive the money until June 2024.


When you leave employment, you can make withdrawals and have the ability to request scheduled automatic payments. You have total control over your investments and continue benefiting from tax deferral even after leaving your employer. In the event of an emergency, you may want to withdraw early. This is when a loan option is also made available to you. Deferred compensation plan withdrawals are mostly subject to tax, but unlike other pension or retirement accounts, the penalty tax doesn't apply prior to age 59.

The advantages of deferred compensation plans

The most obvious benefit of deferred compensation plans is the guarantee of a stable retirement income. You can use this plan in addition to building a considerable nest egg for your later years. The simplest form of income tied to a deferred compensation plan is an annuity, which pays a set amount over a specified number of years. Once you reach the retirement age, you can cash in your life insurance policy or the stocks funds tied to your deferred compensation plan for a more steady income stream.


You also have the option of holding deferred compensation payouts in savings in order to help your children with university tuition expenses, mortgage payoffs, or to ease other financial burdens from your family.

Most contributions that employers make aren't taxable, but the Inland Revenue only taxes the amounts that are withdrawn. Most people usually make withdrawals during retirement, when their income is decreased. Most distributions can be rolled into a traditional IRA for maximum tax benefits. Even employers who offer deferred compensations can reap tax benefits and receive end-of-year tax deductions for their contributions so these savings are advantageous for both the employer and the employee.