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Deferred compensation plans can be a powerful tax planning tool but the nuances can be very confusing. Payments are wages and treated as such for some things but not others.
Q. Hi Dan, I am retiring on Jan. 1, 2016 from a 501c3 not for profit. I have a deferred compensation agreement that stipulates immediate liquidation of my account upon retirement. I will still be "employed" in a different advisory role. Do I pay Social Security taxes on this account and can I make allocations to my 401(k) and 457b accounts since it is (I assume) a w-2 taxable event? Thanks — Howard
A. You will have to check the plan documents to be certain but generally, nonqualified deferred compensation plans don't defer payroll taxes unless there is a “substantial risk of forfeiture.” Once that risk is gone, the payroll taxes are due.
Nonqualified deferred compensation plans are designed to supplement defined contribution plans like 401(k)s and you cannot contribute any of the payout to such a plan nor can you roll the money into an IRA.
These plans can be very helpful but also annoying because the payout schedule is selected upfront and is often irrevocable. Sometimes, the deferred amounts and earnings on those deferrals are paid out in a way that the tax rate applied is higher than the rate that was avoided when compensation was deferred. On the other hand, if you were in a higher tax bracket when you originally deferred the compensation, you did well with your tax planning even if you don't like paying taxes on this liquidation.
Q. Dan, I just read, and enjoyed, your piece titled, "Claiming Social Security: Where confusion reigns". and gained great insight on options for when to start claiming Social Security benefits. I am currently age 59, my wife is 65 and began taking her early benefits at age 62. I cannot find any definitive answers as to how/if she will be able to receive spousal benefits equal to half of mine once I reach age and elect to begin
collecting my benefits. I'm hoping that once I file for benefits, then she would automatically transition to receiving the additional balance between what she is currently collecting and what would be 50% of my benefits. Would you please settle this nagging issue. It would be greatly appreciated. Regards — Russell in Weatherford, Texas
A. Thanks Russell. You are correct that she can't get anything off your record until you file for benefits. When you file, depending on the amounts involved, she may be eligible for an increase due to the spousal supplement. At her age, receipt of the supplement isn't automatic. She has to claim it. Because she filed before her full retirement age, or FRA, when she claims that supplement, her total will be less than 50% of your full benefit.
Q. Dear Mr. Moisand: I turn 70 in late July and intend to continue working at least through the end of this year. The question is when does Social Security consider your 70th birthday; the month of your birthday or the month after? Since I turn 70 before the end of the year, will my benefit next year be somewhat increased as the PIA is determined by a full year's amount and I will not have worked a full year when I START the benefits? I hope you can clarify this for me. Thank you — Lawrence
A. With a July birthday, your maximum benefit would start in August. Any work you do in a given year that is one of your 35 highest earning years as indexed for inflation by the Social Security Administration will increase your benefits, regardless of your age. It doesn't matter how much of the year it takes you to earn that amount.
Dan Moisand's comments are for informational purposes only and aren't a substitute for personalized advice. Consult your adviser about what is best for you. Some questions are edited for brevity .
Reader questions on all things retirement answered Mondays and Fridays. If you have a question for Dan, please email him at: RetireQA@marketwatch.com