Deferred
Compensation Plans
Deferred compensation
plans offer an additional way to save money for retirement. Financial
planners estimate that the average person will need 70% of his/her present
yearly income during retirement. Social Security and work pension plans
probably won't be enough. In fact, they probably won't make up half of
the required 70%. The remaining retirement income needs to come from personal
savings. Deferred compensation plans are a good way to save this additional
money.
Deferred compensation plans are restricted to government employees. Anyone
who is a government employee in an office where a plan is offered is eligible
to join. The investment options available are usually mutual funds that
offer potential for growth as well as security. The employee can choose
in which he/she wants to invest.
- Advantages
- Reduce your current
taxable income.
- Money is withdrawn
before income taxes are charged, thus lowering your tax rate.
- Earnings grow tax deferred
as long as they remain in the plan.
- Contributions are made
through easy and convenient payroll deductions.
- Disadvantages
- Difficult to withdraw
money once it is contributed.
- Fewer options for investment
than offered by a brokerage.
- Withdrawals
- Restrictions are made
on withdrawing from the plan before retirement except for the following
reasons:
- Termination of
service for 30 days
- Death (beneficiary
receives benefits)
- Unforeseeable financial
hardship
More Money Now - More Money
Later. Deferred compensation plans offer the unique benefit of having
more money right now and more money when withdrawn than with other plans.
Now - The money is
removed via a payroll deduction before income taxes are charged. Lower
income means less taxes paid.
Later - Money is growing
tax deferred. Retirement savings are often not tax deferred.
Tax deferral makes compounding more effective and means the investor
pays fewer taxes when the money is withdrawn than if he/she had paid
income tax on the interest throughout the lifetime of the plan.
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