A deferred compensation plan (DCP) is an executive benefit plan that allows executives to defer, pre-tax, an unlimited amount of compensation (salary, bonus and certain forms of equity) and to elect to receive that compensation plus any earnings as a distribution at a future time.
Deferred compensation grows tax-deferred and the plan is not subject to discrimination testing like qualified retirement plans.
From the company’s perspective, these compensation deferrals are viewed as a future promise to pay and are typically structured with an offsetting asset to ensure minimal or no P&L impact to the company. These assets are often held in trust and can grow on a tax favored basis. Mezrah Consulting provides consulting services in designing, implementing and funding new DCPs, as well as ongoing administration for plans through our cloud-based mapbenefits® platform. We also audit existing plans to assess the competitiveness, appropriateness of their design, administration and financing with the goal of minimizing plan costs for the company and maximizing benefits for executive participants. A 17% annual deferral is required to meet a targeted 80% income replacement at retirement. Highly compensated employees are unable to can meet this goal without a DCP due to 401(k) contribution limitations.
Reverse Discrimination for Highly Compensated Employees (HCE)
| Financial Assumptions | |
|---|---|
| Age | 45 |
| # of Deferrals | 20 |
| Retirement Age | 65 |
| Earnings Rate | 8% |
| # of Payouts | 20 |
| Maximum 401(k) Deferrals | $23,000 |
| Income Replacement Target | 80% of Compensation |
| Required Deferral | 17% of Compensation |
Note: An executive earning $500K must contribute the maximum 401(k) amount of $23,000 (i.e. 4.6% of compensation) with the remaining 12.4% required deferral into a DCP to meet an 80% targeted retirement income replacement. An executive earning $500K contributing the maximum 401(k) amount will only replace 21.4% income in retirement.
Value to the Executive
| Advantage of Deferral vs. Taxable Investment | ||
|---|---|---|
| 37% Tax Rate | $1,016,659 | 138% |
| 45% Tax Rate | $1,031,432 | 106% |
| Blended Tax Ratee | $844,170 | 113% |
For illustrative purposes only. Actual results may vary.
Assumes executive age of 45, a hypothetical net rate of return of 8%, and 20 annual payouts beginning at age 65 (note: payouts in the DCP are taxable when taken).
Blended tax rate assumes 37% in years 1-5, 45% in years 6-10 and 50% in years 11+.
Cumulative after-tax payouts assume 3.8% tax on investment income associatated with the healthcare reform legislation.
Securities offered through Lion Street Financial, LLC. (LSF), member FINRA & SIPC. Investment Advisory Services offered through Lion Street Advisors, LLC (LSA). LSF and LSA are not affiliated with 409A Direct, an affiliate of Mezrah Consulting. LSF, LSA, Mezrah Consulting and 409A Direct do not offer legal or tax advice. Please consult with the appropriate professional regarding your individual circumstances.