When companies are dropping like flies is deferred compensation at risk?

Posted on October 15, 2009 by Bill Faiferlick

Deferred compensation is risky especially as companies continue to drop like flies and this is not expected to change based on recent economic data. If the company fails, executives can say good-bye to funds they anticipated having for their retirement or other needs; however, companies regularly use deferred compensation plans as inducements to employment to recruit them.

If the company declares bankruptcy, the assets in the deferred compensation plan are general assets of the company and are subject to the claims of banks and other secured creditors.

“In the 1990s, many companies adopted programs that allowed top executives to defer pay until they needed the money–and to delay paying the taxes that went along with it. Now many of those execs are paying a steep price for that perk. As more companies go belly-up, managers are learning about the danger of “deferred compensation”–namely, that it could be deferred forever” (Business Week – March 2004)

Unfortunately, this has resulted in the loss of wealth for a huge cadre of executives across the country who were relying on those funds for their retirement. The tax benefit they got from the plans may not have been worth the risk to their retirement security. When they defer money, they aren’t subject to income tax on those funds until they are eventually paid. This can provide a nice tax savings. In the meantime, the funds are listed on the books as general assets of the company and are at risk to unanticipated events to the company whether the threat is internal (mismanagement) or from an external source.

Taking this a step further, there are many companies or executives who never defer income or make promised contributions to match future promises. As a result it is a best guess approach as to whether those deferred compensation plans are ever funded or received by anybody.

The biggest threat to these plans today is the fact that we live and work in a global economy and it could be that an international company a world away could derail a previously profitable US firm to survive. This would make it impossible for companies to make good on past promises, i.e. funding often years of past payments regardless of good intentions.

For dental and medical professional practices, deferred compensation is financially punitive as it increases the overhead non-deductible expenses. The required additional withholding of taxes, taxes that would otherwise not exist, increases overhead expenses and reduces income to every other physician or dentist.

For younger doctors or dentists in a practice, where there is a deferred compensation plan, they are unknowingly agreeing to have their incomes reduced as revenue from the practice which is being deferred by the older dentists is taxed to the company based on the size of those deferrals reducing cash flow for the business and funds available for the professionals in the practice.

Other strategic opportunities are available to protect funds on a tax deferred basis which are guaranteed under ERISA that provide many more benefits to business owners and executives. Skepticism and caution are needed to proceed with deferred compensation plans because regardless of good intentions, many circumstances beyond the control of the company could wipe out those promised benefits.