Beware of Deferred Compensation Plans!

Deferred compensation plans are very similar to other retirement plans, but beware: There might be a sting in its tail!

There are many kinds of these plans. Examples include pensions, some retirement plans, and stock options. But it's the plans that companies put together and then invite their highly paid workers to participate that could put your money at risk.

It is my opinion that these type of deferred compensation arrangements are not really retirement plans.

Such a plan allows you to contribute money from your salary, your bonus, or your sales commission to an account where the balance grow on a tax-deferred basis. You don't pay tax on your contribution and the income earned by the account is not taxed. When you draw from this account you'll be taxed on the money withdrawn.

The risky part is that these accounts are under the control of your employer and not under the control of a regulated insurance company. And the fortunes of companies, large and small, are unpredictable at the best of times.

Many years ago I participated in such a plan. I guess I didn't fully understand the plan at the time. After about two years I started to get very nervous. The company was going through a rough patch and I knew that if the company folded, my deferred compensation account balance would be gone too.

Fortunately I was allowed to draw against the account and I stopped contributing. I depleted the account as fast as I could. Coincidentally, at that time I was tax resident in a low tax country and the whole episode worked out well for me!

In boom times stock options and deferred compensation arrangements seem to be unbeatable. However, what goes up must come down!

It is my opinion that these arrangements are too risky in the long run. It should certainly not be a component of your retirement plan.

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