deferred compensation plan

deferred compensation plan

from Businessweek

If you've been offered the deferral option, should you take it?

First, evaluate your finances and your company's financial stability--if your company goes bankrupt, you could lose the money. While 401(k) participants are protected in bankruptcy, those in deferred comp plans line up with other unsecured creditors.

Then consider the quality of investment options offered in the plan and the impact of future tax rates, which are expected to rise in 2011 when the Bush tax cuts expire.

Those looming tax increases are one of the biggest factors to consider. If you defer, you must decide how long to defer; the minimum period is two years. That means if the Bush tax cuts expire, you'd be taking the money out at a higher tax rate--39.6% vs. 35% in the highest bracket. So you'll need to offset that either by earning more in the plan or by investing over a long enough period that compounding will make up the difference.

if you can defer for only a few years, it isn't worth it. Consider: If you receive a $100,000 bonus and don't defer, you'd keep $65,000 (at the highest tax rate, excluding state taxes). If you then got 6% on your investment, you'd have $81,144 aftertax in five years. If you deferred that $100,000 and made the same 6%, withdrew the funds in five years, and paid the higher tax rate, you'd have $80,829--so deferring wouldn't pay.

defer for closer to 10 years, if not longer. If you deferred $100,000 for 10 years and earned 6% a year, then paid taxes at the higher rate, you'd net $108,167 vs. $101,410 if you didn't defer. "You need to defer long enough to make it worthwhile if you're going to take money out at a higher tax rate

State taxes matter, too. Deferring is especially worthwhile if you move from a high income tax state, such as New York or California to a low- or no-tax one, such as Texas or Florida, by the time you get your distribution.

Do you have better investment options outside the plan? Might be best to pass on deferring pay.

Do you have other assets to tap if you're laid off, making long-term deferral less risky? Then deferring would probably be worthwhile.