One of Benjamin Franklin’s timeless quotes is “in this world nothing can be said to be certain, expect death and taxes.” I don’t think much can be done on the former, but on the latter, there are strategies that help. While we can’t make taxes go away altogether (sorry), we can assist in minimizing them. Several of Mainspring’s offices are located near large corporations where certain employees can opt in to using deferred compensation plans (“deferred comp”). This is a uniquely good fit for those who have much higher income now than they expect to have in retirement.
Understanding Deferred Comp Plans
Deferred comp plans allow eligible employees to delay receiving a portion of their income (salary, bonus, or both) until a future date. That money goes into a 401(k)-like investment portfolio today, and generally is withdrawn in retirement. This often moves them into a lower tax bracket while they are in their peak earning years. For high-income professionals, especially in industries like tech where salaries and bonuses can be substantial, these plans can lead to significant tax savings and compound growth over time.
Deferred Comp & Company Stock
Many employees that can utilize deferred comp plans also have company stock. This can either be due to purchasing it through an employer stock purchase plan (ESPP) or because they are granted stock as part of their pay. They often build up a lot of stock in the same company that also pays the bills. To avoid putting so many eggs in one basket, selling company stock to replace the income going info deferred comp can be a best of all worlds. This can help minimize taxes today, while still providing the liquid funds needed for immediate lifestyle expenses or lump sum purchases.
An Illustration
Consider the case of a level 67 software engineer at Microsoft. With a base salary plus bonus and stock grants, they often end up in the 32% tax bracket or above. By participating in Microsoft’s deferred comp plan, the engineer can defer a portion of their income, saving it for the future.
If the engineer defers $50,000 of their annual income, assuming a federal tax bracket of 32%, they’ll save roughly $16,000 in taxes today. Investing this amount in a tax-deferred account will allow it to grow, potentially turning into a much larger sum by at retirement. Coupled with strategic investments in ESPP and careful management of stock vesting, they can effectively lower their immediate tax liability while planning for long-term goals.
This is a hypothetical example for illustration purposes only. Actual investor results will vary.
The End Goal
For most taxpayers and CPAs, the goal is to minimize taxes today. As financial planners, we also love to help our clients send less to Uncle Sam. If one can defer income today when they are in the 32% (or above) bracket and take it out later in the 24% (or below bracket), this can be quite attractive. However, there is a good chance tax rates could be significantly higher in the future, especially for high earners. Because of this, we don’t believe there is a one size fits all recommendation when it comes to deferred comp. There are times we tell people to pay more in taxes today because it will help them save big time in the future.
As a lifelong resident of the Pacific Northwest, I’ve observed the dynamic growth of the tech and professional services sectors here. We have seen many incomes rise in a big way, and that has come with more taxes. Our goal is to help our clients make the very most of what they earn and save, so they can live their best lives, support their families, and make an impact on their communities. Deferred comp is a solution that makes sense but it’s important to talk through the pros and cons. We are here to walk through these strategies whenever you’re ready!
