What is deferred compensation, how does it work, and which option should you pick or how much should you defer if you are ever given the option?  If you’ve heard of deferred compensation but didn’t know if it was the right choice for you, you’re not alone.

One person online had this question, and took their concerns to the people in the r/fatFIRE community — a group of people focused on financial independence and early retirement with “a fat stash” of money. Here is what they said.

Please remember, that this article and the comments in the original thread are opinions. You should always speak with an expert before making any kind of significant financial or legal decision.

The Question

After a recent promotion, the author of the post in question became eligible for deferred compensation. The plan said that up to 50% of salary could be deferred and that up to 90% of bonus payments could be deferred. Naturally, the deferral would impact how much money is contributed into their 401(k). The author can pick from various options where the deferred compensation will go, which match the return of a 401(k) for the most part.

They gave some background about their financial situation. They earn around $700k per year and have around $3.5 million in net worth, spread across various investments and holdings. They have an annual expense of around $100k.

Their gut reaction was to maximize the bonus deferment but weren’t sure how much to defer from their salary. They wanted to hear what everyone else had done and what their strategies were, and how salary deferment fit into their early retirement plans.

The Community Response

Most of the people who responded in the thread were extremely reluctant to endorse the idea of participating in the salary deferment plan, and others recommended against participating if the user was younger (which they are, around 30 years old).

There are a few reasons for this.

First, the money withdrawn from the deferment plan is always taxed as earned income and doesn’t benefit from any tax-deferment options. This means that if you withdraw that money at the end of the deferment period, usually around 10 years after leaving the company, then you will have a huge tax bill probably around the time you are relying on the money for retirement.

Second, there is always a risk that a company could go bankrupt or not be able to pay out the deferred salaries. This is more of a risk with the new companies that need to use salary deferment to survive. In the event of a bankruptcy, it is the shareholders that get paid first, not the employees.

Third, deferred compensation plans tie you to your company for a fixed period of time, no matter what happens in your life. You can’t leave the company until the period is over to get your deferred compensation back. People call these “golden handcuffs” and it is usually unwise to tie yourself to a company so far in advance when you don’t know what might happen.

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