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Why Executives Plan for a 2013 Bonus in June

June 07, 2013

Why CEOs Plan for Their 2013 Bonus in July

People who defer their bonus have to specify when they'll start taking withdrawals. Photograph by Rene Mansi

To defer or not to defer? That is the question for executives expecting a 2013 bonus.

They have until June 30 to put some of their reward in a deferred compensation plan, if their company offers one. The accounts are a way top managers can save for retirement without paying current income tax on amounts above the annual contribution limits of tax-deferred 401(k) accounts, which in 2013 is $17,500 for people under 50 and $23,000 for those over 50.

Deferring might be an attractive option at the moment, with higher federal tax rates for top earners this year and increased levies in states such as California, said Robert Barbetti, head of executive compensation advisory services for J.P. Morgan Private Bank in New York.

About 76 percent of chief executive officers at Fortune 100 companies had these deferred compensation plans last year, slightly more than in 2011, according to Aaron Boyd, director of governance research at executive-compensation data firm Equilar Inc. Some companies offer the plans to other highly paid executives and managers, said Andrew Liazos, a partner at the law firm McDermott, Will Emery.

Here are six things executives need to consider when deciding to defer (fingers crossed) a 2013 bonus.

1. Where do you plan to live?

Executives in high-tax states such as California, Minnesota or New York who envision retiring to states with low-or-no income taxes may save money by deferring, said Liazos, who specializes in executive compensation.

That's because the state where they earned the compensation, say, New York, can't tax the income once they're a resident of sunny Florida or Texas -- as long as withdrawals from the plans are taken over a period of at least 10 years. "The best thing about deferring in a high-tax state is that you may end up in a state with much lower taxes when you ultimately receive the distribution," said Barbetti.

2. Can you afford it?

Think about how much cash you need. People who defer their bonus have to specify when they'll start taking withdrawals. That timetable generally can't be accelerated.

Find out what options your company's plan has for payment triggers, such as retirement from the company or a specific date. Also check out the choices you have for distributions including a lump sum or installments, said Liazos. Some plans are more flexible than others.

3. What are the investment options?

Most deferred compensation plans let executives invest the money in mutual funds the same way they do in 401(k) accounts. Some plans may offer a private equity option or a fixed rate of return. People who don't think they can get a reasonable rate of return inside the plan should consider taking the compensation and investing outside of the plan, said Barbetti.

4. How long can you defer?

Given the level of tax rates in most states, Barbetti figures executives need to think about deferring for a minimum of five to seven years.

While putting a bonus in a deferred comp plan postpones paying taxes on that money, it will be taxed as ordinary income when withdrawn. The top federal income tax rate is 39.6 percent currently versus as much as 23.8 percent for long-term capital gains.The longer the deferral the more time the money has to compound before tax bite. Earnings on investments outside the plan may be taxed at lower capital gains rates.

5. Will your company match?

Some companies will match a portion of a manager's contributions to a deferred compensation plan if you invest the money in the firm's stock. It could be a worthwhile option if you think the shares will perform well and they pay a dividend.

6. What's your company's outlook?

Corporate bankruptcy is the biggest risk for executives with deferred compensation plans. People in the plan are, after all, unsecured creditors and may not get those funds back, Liazos said.

Those who decide to defer should review whom they've designated as a beneficiary. They also may be able to set aside some of their 2014 salary -- but that decision doesn't have to be made until Dec. 31.

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