Make sure you understand the benefits of Deferred Compensation plans

For high-earning executives and professionals, a Deferred Compensation Plan (DCP) can be one of the most powerful — and underutilized — retirement planning tools available.

By deferring income and taxes into future years, participants can retain more investable dollars, harnessing the power of tax-deferred compounding. For those in the top income brackets, this strategy can significantly enhance long-term wealth accumulation while managing annual tax exposure.

In this guide, we’ll explore how Deferred Compensation Plans work, their advantages and risks, and how to decide whether they align with your long-term financial goals.

By Brennan Decima, CFP®, Financial Advisor Specializing in Executive Benefits

Key takeaways

• A Deferred Compensation plan allows you defer compensation above and beyond the annual 401(k) limits on a pre-tax basis.
• By delaying taxes, this allows you to keep more money invested. Increasing your compounding.
• Installment plans for distribution can potentially lower your tax impact even more
• If your company files for bankruptcy, you may lose your money in the deferred compensation plan.

What Is a Deferred Compensation Plan?

For many of the clients that we work with, they are focused on maximizing their savings as they prepare for their next chapter in life. We regularly work with high income earners whose top priority is to lower their taxes. As a general rule of thumb, most retirement experts suggest saving 15% of your income on a pre-tax basis. You may be wondering how it is possible to save 15% pre-tax if you make over 300k, 400k, 500k each year. For a 400k income, 15% is 60k. This is double what 401(k) limits are in 2025. Enter the Deferred Compensation Plan. This powerful account allows higher income earners to lower their tax bill, and save more money for retirement.

If you are a high income earner who enjoys the tax deduction that comes with your employer savings plan, you will love the deferred compensation plan.

Deferred Compensation plans are usually offered by an employer to highly compensated employees. This allows the employees to save more in a tax advantaged account than they normally would be allowed with a 401(k).

Three Core Benefits of a Deferred Compensation Plan

The main advantage of deferring your income in a deferred comp plan is tax deferral. This works very similar to making contributions pre-tax to a 401(k), but without the annual limits.

The IRS does not have any limits on how much of your compensation you can defer. Typically each employer will have rules on what percentage of your compensation is allowed to go into the plan. However, these rules are usually percentage based, so they don’t cap higher earners when they reach a certain dollar figure.

The second advantage is the power of compounding. By deferring a portion of your salary, you are postponing paying taxes. This allows you to keep more of your money invested, allowing for greater compounding. The higher your tax rate, the bigger this benefit becomes.

Advantage number three is the company match. Many companies continue making the company match to deferred compensation plans, allowing you to receive more dollars from your company above and beyond the 401(K) limits. (Not every company offers this, check your plan summary)

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Deferred Compensation vs. 401(k): Key Differences

Deferred Compensation plans work different than the usual employer savings account. 401(k)’s typically allow employees to defer a percentage of their salary into trust account, and then invest those funds in a selection of investment options. Deferred Compensation plans work as a contract between you and your employer to defer a portion of your compensation until a predetermined future date. For some companies, that date is at separation. A large pharmaceutical company that I support allows their employees to defer their compensation for 5 years, 10 years, or later, regardless of whether they are active or not. This allows their executives to plan for events like college or home purchases, and defer the income and taxes until they plan on utilizing it. In that circumstance, the deferral strategy isn’t just for retirement. Check your plan to see if they allow distributions while you are working.

Most large companies provide deferred compensation because 401(k) plans do not allow high earners to safe enough money.

	401(k)	NQDC
Annual limit on amount employee can defer	Yes, subject to annual IRC limits	No IRC limits, but employer may have limits
Required Minimum Distributions	Yes, unless still an active employee	No, but payout is set in advance
Flexible distributions	Depends. Once you leave the company or turn 59.5, you have significant flexibility.	No, payout typically set in advance
Eligible for Rollover to IRA	Yes	No
Funds protected from creditors in bankruptcy	Yes	No
Eligible for Loans	Yes, depending on employer rules	No

How to decide how much to defer in Deferred Compensation

Deferred Compensation enrollment typically happens once a year during your company’s annual enrollment. This is often right before year end, and the enrollment typically lasts a few weeks. Depending on your company rules, you will want to see what portion of your pay structure is eligible for deferral. Some plans only allow salary. Other’s allow bonus or stock awards.

The decision for enrollment is usually an irrevocable one. Unlike 401(k) plans, you typically don’t have the ability to make adjustments to the deferral amount during the year. It is incredibly important to make sure you have done the right planning to make sure you are not put in a tough financial spot between enrollments. Before you decide to enroll, here are some key things to consider.

• Your income needs: Do you have renovations or tuition costs coming up? Will you have the liquidity you need to pay your other expenses and deductions?
• Tax Bracket: Deferred compensation is not reported as taxable income until you start your distributions. Will your tax bracket be lower or higher in retirement? For many executives, deferring income may help them avoid higher tax brackets during their peak earning years.
• Deferral time period: Decide how many years you want to defer income. Do you want payments to begin when you retire? In 5, 10, or 20 years?
• Distribution Flexibility:  Many plans have strict limits on the distribution options. Does your company allow you to adjust your distribution schedule? If so, when can you adjust?
• Distribution Schedule: How do the payouts fit into your future plans? The default option for many Deferred Compensation plans is a lump sum. Will that lump sum put you in an adverse tax situation upon separation from your company? If there are installment options, would that allow you even greater compounding power?

Planning Deferred Compensation Distributions in Retirement

Deferred Compensation plans require that a distribution selection is made in advance. You will need to choose when the money pays out, and over what time period. Keep in mind that the distribution rules for deferred compensation are much different from 401(k)s or IRAs.

Deferred compensation plans don’t have required minimum distributions or a requirement to wait until 59.5. Typically, you have the ability to choose if you want the distributions paid as a lump-sum payment or in annual installments. Here are a few considerations:

• Lump-sum: Choosing the lump sum option gives you complete access to all your money upon separation or retirement. This can be both a good thing or a bad thing. If you have other payouts that may occur at separation, such as incentives vesting, a bonus, or a potential severance, the lump sum could be taxed at a higher rate than when you deferred it. On the other hand, you may have concerns about your former employer retaining control. Once you receive your lump sum, you’re also free to spend or invest the funds. However, you will be responsible for paying income tax on the entire lump sum in the year that it pays out.
• Installments: With installments, you receive your distributions over a set period of time. The balance of your deferred compensation stays in the account, where it can continue to grow tax deferred. By spreading your distributions over multiple years, you may substantially reduce the taxes you owe. If you expect your tax bracket to be lower in retirement, or if you plan to continue working when you leave the company, installments can help better control your tax liability.
• Key Point: State taxes on deferred compensation payouts are typically due in the state the money was earned, even if you are no longer a resident. However, if you choose to take your distributions in installments 10 years or greater, you may have the ability to pay state taxes in the state where you reside. This is particularly powerful if you are considering relocating from a high tax state to a low or no tax state.

Important Risks and Considerations

Credit risk.  Deferred Compensation plans are an unsecured promise by your employer to pay your account balance in the future. These plans are not covered by the Employee Retirement Income Security Act (ERISA), which protects 401(k)’s if the company runs into financial trouble.

Deferred Compensation participants could potentially lose some or all of their assets if the company goes bankrupt. Since it is unsecured, you would not get paid out until the secured creditors of the company were taken care. .

No Loans or Rollovers.  Deferred Compensation plans do not allow you to take loans or rollovers.

Lack of flexibility. Distribution elections must be made at enrollment. Some plans may force payments at a set time. It is important to evaluate your plan documents and future liquidity needs.

FAQs About Deferred Compensation Plans

1. Should I maximize my 401(k) before participating in Deferred Compensation?  Yes, you should be making the maximum contribution to a 401(k) plan before you consider enrolling in your deferred compensation plan. Be aware that some company’s allow simultaneous contributions, so cash flow planning becomes even more critical.
2. Is my employer financially secure?  Since this is a promise to pay at a future date, it is important that your employer is in a financial position to make good on the agreement.
3. Does the plan allow a flexible distribution schedule?  Many companies require the distribution schedule to be set at the time of enrollment. There are also scenarios like a change in control which could cause a large lump sum payout. Make sure you review what distributions options you have prior to deciding whether or not to enroll.
4. Should I enroll in Deferred Compensation?  If you are in a high tax bracket, and have enough liquidity outside of the deferred compensation plan to handle changes to your financial situation, Deferred Compensation may be a good fit for you.
5. Are you comfortable giving up flexibility?  Deferred Compensation money is typically not available until the preset distribution date. Unlike a 401(k), loans and hardship withdrawals are typically not permitted.

Next Steps: Building Your Executive Retirement Strategy

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