The Importance of Nonqualified Deferred Compensation in a Second Obama Administration

Sunday, April 1, 2012
American Benefit Corporation's Jim Herlihy has just released a new article discussing the tax advantages of a nonqualified deferred compensation plan in any tax environment.

As the political landscape - on the presidential level - becomes clearer it appears that President Obama will be running against Governor Romney. The tax positions of both candidates could not be more different.

President Obama has repeatedly called for an income tax increase on the wealthy, which is anyone earning in excess of $250,000 per year. Governor Romney, on the other hand, has stated his intent to decrease income taxes in an effort to stimulate job creation. Political commentators continue to tell us that the election is primarily about the economy and taxes. If President Obama is reelected and the Democrats pick up a few seats in the Senate, an income tax increase becomes almost a certainty.

For those higher earners who are corporate executives Nonqualified Deferred Compensation, regulated by IRC 409(A), offers an opportunity for current income tax reduction. It also offers the opportunity to avoid capital gains taxes on investment changes and possible state tax exemption when the funds are distributed.

IRC 409(A) provides detailed guidance concerning the structure of a Nonqualified Deferred Compensation Plan. Some of the more important provisions relating to taxes are as follows: 1. Plans may permit the pre-tax deferral of up to 100% of base and bonus compensation. 2. Investment gains, if any, are tax deferred. 3. Investment reallocations do not generate income tax or capital gains tax to the executive. 4. All distributions from the plan are taxed as ordinary income. 5. A federal tax statute permits deferred compensation payments of 10 years or greater to be taxed in the state of residence at the time they are paid. Residence in a state with no income tax (i.e., Florida) would avoid a state tax on deferred compensation payments.

The following table illustrates the tax efficiency of a Nonqualified Deferred Compensation Plan:

The above illustration is based on an executive currently age 50, deferring/saving for 15 years and electing a 10-year payout at age 65.

Current Tax Bracket Years 2012 Forward Tax Brackets
Federal 33% Federal 39.5%
State 7% State 10%
Total 40% Total 49.5%

This table compares the retirement funds accumulated by an executive with an after-tax strategy vs. a deferred compensation strategy. The deferred compensation strategy creates 46% more annual after-tax income than the after-tax strategy and if the retirement state of residence (Florida, New Hampshire, etc.) does not have a state income tax, the deferred compensation strategy creates 75% more annual after-tax income. The payout period must be ten (10) years or greater to avoid state income tax in the state where the funds were deferred.

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.