More executives are taking their bonuses and salary as deferred compensation spread out over time, avoiding immediate tax hits.
But they also are becoming better versed in the trade-offs that come with these pay arrangements. And their financial advisers have become more active in laying out the tradeoffs, which include losing quick access to some earnings and, in a worst-case scenario, losing the money itself.
Jorie Johnson, an adviser in Manasquan, N.J., recently reminded clients to look twice at any employer’s offer of deferred comp. The pay isn’t protected from creditors, can be withdrawn by executive management and is out of reach in a financial emergency, Ms. Johnson noted in an email she sent to executives with whom she works.
Deferred comp has resurfaced as a topic among her clients as employers return to paying bigger bonuses, says Ms. Johnson, a certified financial planner at Financial Futures, which has more than $40 million under management. Many financial executives could see as much as a 10% increase in their bonuses this year compared to 2011, according to New York-based compensation consulting firm Johnson Associates Inc.
The prospect of higher income-tax rates next year may discourage some from deferring compensation. Advisers plug higher tax rates into models they use to help clients decide how much, if any, to defer, and for how long. Executives who expect to retire in the not-too-distant future, however, may defer despite expected rate hikes because they can time payments to take them up to the moment when they stop work and enter a lower tax bracket.
“Senior level managers at investment banks may think about the option of deferred comp, where before they might not have,” said Ms. Johnson, who has heard from clients worried about taxes when they learn they stand to get, say, a $300,000 bonus after years of collecting smaller awards.
The bankruptcy of giant Wall Street firm Lehman Brothers in 2008 showed the dangers of deferred comp, as many of the firm’s employees were unable to collect. When a company goes under, an executive who deferred a bonus or other pay must get in line with other unsecured creditors. Other corporate events – an acquisition, for example – can threaten deferred comp as well.
Indeed, an employer’s financial health is a key part of the equation when deciding whether or not to defer. David S. Morgan, an adviser in Oak Brook, Ill., said his firm tailors its advice according to where a client works.
“We would be much more comfortable deferring compensation when the employer is McDonald’s, for example, than if it was a start-up company,” said Mr. Morgan, a principal at JMG Financial Group Ltd., a registered investment adviser with more than $1.4 billion under management.
For one client of Mr. Morgan who worked at a Fortune 100 company, the credit risk seemed low enough to make deferred comp a good option. The man, who planned to retire at age 58, deferred 50% of salary and 100% of bonuses he got while on a four-year assignment overseas during which his employer paid most of his living expenses.
The man arranged to have the compensation paid to him over 12 years. Those payments will carry him to age 70 1/2, when he must take money from his 401(k). The goal, according to Mr. Morgan, was to have the man spend the deferred comp first because it isn’t credit-protected.
Now age 60, the client is living comfortably off the cash flow from the deferred comp.
(Arden Dale is a Getting Personal columnist who writes about personal finance; she covers topics including tax and estate planning, retirement, investment strategies, and financial needs of small businesses. She can be reached at 212-416-2234 or by email at arden.dale@dowjones.com.)
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