A number of larger companies offer elective Executive Deferred Compensation Plans. These are essentially plans allowing certain employees to elect to defer a portion of their salary/bonus compensation before it is earned. The advantages can be enormous. One can elect to defer a portion of their salary or bonus, thus avoiding current income taxes and allowing their deferred income to grow through investments on a tax-deferred basis until a pre-determined time. Usually this time is either termination of employment or retirement. It is also possible with some plans to time the end of a deferral period to coincide with a child’s education or other funding needs.
Disadvantages to deferred compensation are few but very serious. First and foremost, when you defer income you are giving up the right to income now (employment) for a mere promise to have it paid to you in the future. This effectively lowers your creditor standing should your company fail. When you’re owed salary as an employee you are typically high up in line as a creditor during liquidation. But if you were owed deferred income, your status would be that of a general creditor, much lower in claim priority line during bankruptcy proceedings. Deferred compensation investment alternatives are often limited and sometimes only company stock is available as a choice.
Executive Deferred Compensation Plans can be useful tools to help control current income taxes and plan for future funding events. One has to be mindful of current and anticipated cash flow needs. I advise clients to be careful not to overdo it, taking on too much risk.