When should I start deferred compensation?
Aerospace Executive Edition

For executives in the defense and aerospace industries, deferred compensation can be a valuable tool for long-term financial planning. It provides an opportunity to set aside a portion of income for future use, typically in retirement, rather than taking an immediate payout. At AdviceOne, we understand the complexities of deferred compensation; while it offers significant advantages, it also requires careful planning to ensure it aligns with your personal financial goals and obligations.

Understanding Deferred Compensation

Deferred compensation allows executives to delay receiving a portion of their income, including bonuses. This allows you to defer income taxes on that money into retirement, and you’ll have the ability to grow your balance through investments. Deferred compensation may offer benefits such as tax deferral and potential investment growth. While you have limited ability to defer your Long-Term Incentives, such as SARs, you can defer income from other sources to help balance fluctuations in total compensation.  

This strategy can enhance retirement savings while providing flexibility in financial planning. However, the decision to defer compensation should be based on an individual’s broader financial situation, investment approach, and risk tolerance.

 

Types of Deferred Compensation

Deferred compensation can take different forms, tailored to the needs of executives and their organizations. Common types include:

• Elective Deferred Compensation: Executives voluntarily defer a portion of salary or bonuses. These funds are often invested in various options provided by the employer. An example of this kind of plan would be the RTX Compensation Deferral Plan.
• Nonqualified Deferred Compensation (NQDC): These plans provide additional retirement savings options beyond qualified plans like 401(k)s. While they offer flexibility in contributions and payouts, they also come with certain risks, such as exposure to employer solvency. An example of this kind of plan would be the now dormant UTC Company Automatic Contribution Excess Plan.

Deferred compensation can complement other retirement savings strategies, allowing executives to manage taxable income more effectively.

 

Key Considerations and Strategies

Setting Limits and Investment Strategies

Most employers set limits on the amount that can be deferred, usually based on a percentage of salary and bonuses. Once deferred, funds can be invested similarly to a 401(k), with younger executives often taking a more growth-oriented approach and shifting toward balanced portfolios over time.

Timing Your Deferrals

Determining when to begin deferring income is crucial. While early deferral can provide long-term benefits, it is important to ensure sufficient liquidity for unexpected financial needs.  At AdviceOne, we recommend having a least double the amount you plan to defer readily available in accessible accounts to get you through any emergencies that may pop up.

Tax Considerations

Tax policies evolve, and changes in tax brackets can impact the effectiveness of a deferred compensation strategy. Optimizing deferred compensation before and after retirement allows executives to better manage their overall tax picture. This may include the ongoing exercising of awards for the next 10 years after separating from service, while preserving other accounts for future income needs. 

Payout Structures

Before retirement, executives may have the opportunity to adjust payout schedules for deferred compensation. These decisions should be made with an understanding of tax implications, cash flow needs, and investment goals.

 

Case Study: Maximizing Financial Flexibility with Deferred Compensation

John Smith, an aerospace executive, wanted to optimize his financial planning as he neared retirement. With a substantial portion of his income coming from stock options and performance-based incentives, he faced variable earnings and potential tax challenges.

After consulting with his advisor, John chose to defer part of his salary and bonus into his employer’s NQDC plan. This approach allowed him to:

• Reduce his immediate tax burden while increasing retirement savings.
• Align his financial strategy with changing tax regulations.
• Maintain flexibility in managing income and investments over time.

 

Through careful planning, John struck a balance between tax savings today and income for retirement. His case highlights the importance of aligning deferred compensation decisions with broader financial goals.

 

Conclusion

Deferred compensation can be a valuable component of an executive’s financial strategy, offering tax advantages and long-term savings potential. However, its effectiveness depends on thoughtful planning, including investment choices, liquidity considerations, and tax implications. By making informed decisions, executives can optimize this tool to support their financial future.

 

AdviceOne Advisory Services, LLC (“AdviceOne”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where AdviceOne and its representatives are properly licensed or exempt from licensure.

This information is general in nature and should not be considered tax advice. Investors should consult with a qualified tax consultant as to their particular situation.

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

Any case study that is provided is for illustrative purposes only to provide an example of the firm’s process and methodology. The results portrayed in any case study are not representative of all client situations or experiences. An individual’s experience may vary based on his or her individual circumstances and there can be no assurance that the firm will be able to achieve similar results in comparable situations. No portion of any case study is to be interpreted as a testimonial or endorsement of the firm’s investment advisory services. The information contained herein should not be construed as personalized investment advice.