Deferring Income in an Uncertain Tax Environment

Saturday, October 1, 2011
American Benefit Corporation's Jim Herlihy has just released a new article explaining how income deferral is valuable, even in an uncertain tax environment.

In a recent article in the Wall Street Journal Karen Blumenthal questioned if boomers were ready for the great retirement income scramble. The need for retirement income is imminent and most boomers have not accumulated adequate funds.

Several years ago a wealthy investor told me that he had experienced two types of tax problems. The first was having to pay too much in taxes because he had too much income. The second was paying too little in taxes because he had too little income. He went on to tell me that having to pay too much in taxes is always preferable to having too little income.

Most highly compensated executives realize that company sponsored 401(k) plans and defined benefit plans are not going to provide them an adequate income replacement ratio at retirement. The solution to this deficient income replacement ratio is to defer pre-tax income into a company sponsored non-qualified deferred compensation plan, even if income taxes increase in the future. Remember - paying too much in taxes is always preferable to having too little income.

The current income tax environment continues to breed uncertainty. Income taxes on the highly compensated may increase in upcoming years, but no one can say with certainty if they will. It is known with relative certainty that Republicans will attempt to block any future tax increase. An executive who attempts to develop a personal investment portfolio with personal after-tax money will incur taxable income each year on realized gains. Invested assets in a non-qualified deferred compensation plan avoid all of these taxes until there is a plan distribution. These advantages continue during the retirement payout period. The longer the payout period of the deferred compensation account, the greater the advantages become.

Consider the following situation with a rising tax bracket in 2013:

  • Current tax bracket: 33% federal, 7% state
  • Tax bracket at payout: 40% federal, 10% state
  • Current age: 50
  • Retirement Age: 65
  • Distribution period: 20 years

An executive who is currently age 50, has a 40% tax bracket increasing to 50% in 2013, will have an after-tax annual deferred compensation payout of $101,465 for 20 years if he defers $100,000 per year for 15 years and it earns 6% each year. If he resides in a state that does not have a state income tax, his after-tax pay out increases to $121,758. However, if he elects to accumulate retirement funds without the benefit of a non-qualified plan, paying taxes each year, his annual after-tax pay out will only be $64,617 for 20 years.

Tax deferred compounding works, even in a rising tax bracket. Income deferral and residence in a state with no income tax provides an 88% increase in after-tax annual income over not deferring, while residence in other states provides a 57% increase, still substantial.

An unpredictable economy has made retirement planning strategies more difficult. A non-qualified deferred compensation plan can make it easier.

About Us

At American Benefit Corporation, we design, fund and manage executive non-qualified benefit plans for highly compensated corporate executives who wish to reduce current income taxes and form personal capital on a tax efficient basis. Established more than 30 years ago, we serve the unique needs of executives in numerous corporations with their personal capital formation objectives.

This material is intended for informational purposes only and is not intended to replace the advice of a qualified tax advisor. Investments in securities involve risks, including the possible loss of principal. When redeemed, shares may be worth more or less than their original value.