While this paper offers a number of interesting observations and insights, two of its conclusions particularly address this question:

Although distributions from nonqualified deferred compensation plans are taxed at ordinary income tax rates upon distribution, this disadvantage versus capital gains taxation on after-tax investing often is outweighed by the long-term tax-deferred earnings on pre-tax gross contributions.
In all but the most significant tax-rate increase situations, and except for very short-term deferral and distribution scenarios, deferred compensation outperforms after-tax investing.

A similar study was performed by CAPTRUST Financial Advisors (Dissecting the Deferral Benefit, see www.captrustadvisors.com). Their analysis yields similar results, and they offer four factors that lower the risk of negating the benefits of deferring income:

Higher marginal income taxes during the accumulation phase
Longer time period for tax-deferred accumulation
Higher investment earnings
Longer payout period during the distribution phase

Both the analysis and the conclusions associated with this tax and investment question are complex. But the bottom line is that deferral of income offers a key employee numerous benefits while the risk of eventual tax increases is so uncertain as to be nearly moot. For employers interested in incentivizing key employees to do good work and stay with the company, deferred compensation plans continues to offer a powerful benefit.

Instant Insights /

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