Are you a high paid employee? Maybe deferring your compensation makes sense for you.
Welcome everyone to another edition of the Highball Advisors Railroad Retirement whiteboard. My name's John McNamara of Highball Advisors, and today we're going to talk about deferred compensation. What is deferred compensation? You might have heard that term before. It's really towards the people on the higher end of the salary ranges at railroads. Highly compensated employees.
What you can do is defer your salary and thereby deferring your taxes. If you're a high salary individual, you're up at that 30%, 37% bracket perhaps, 35, 37% bracket. Say, oh boy, I'm paying a lot of taxes up here. Maybe I can defer my salary, take it at a later time when you retire and then I'll pay the taxes then.
There's a couple questions you want to be asking yourself as we go through this to help guide you through. This will be high level stuff. Reach out to your advisor to go into more detail, but this will give you a good primer, so to speak.
First is, did you max out your 401k contributions? Why are you deferring if you can just do it in the 401k. Max that out. It's closer, probably around $30,000 now here in 2023, assuming after 50 so you want to max that out. That's a tax deferred vehicle right there is your 401k so get that taken care of.
How about are you maxing out your HSA? Another, my favorite tax deferred vehicle, triple tax free. Okay, you're maxing out these two vehicles now, oh, okay, well maybe this makes sense for me, this deferred compensation plan so we'll continue on.
How will deferring income affect your taxes? That's an interesting point too. You want to make sure that you're bringing down your tax rate. Maybe you're moving yourself down into another lower bracket. Instead of paying it, like I say, that 35, 37% on money, maybe you can get yourself down into the 24% bracket and keep it there and then defer the higher bracket money out. Tax planning, big part of your life is going to be figuring out taxes. Really need, got to get help on that if you don't understand it.
Then how much should you defer of your income? That's kind of a, hey, what do I need to live on so to speak. Do I need X amount or do I need X plus amount? Figure out what you need, put a little cushion on there also and then everything else might be able to be deferred. Understand that, how much you can defer.
Then you should, the next one is when you should receive the deferred income. What happens is you have this deferred compensation plan, then you retire from the railroad, and then you're going to get paid out on the deferred compensation. It's important to remember how you get paid out. If it's going to be a lump sum, that's going to be a big problem because all you're really doing is just generating a huge tax liability when you retire. Oh, here's a pile of money, you've just retired, oh, that puts me in the 37%, the highest bracket. Maybe when you're retire, the bracket might be higher.
You want to be able to spread those deferred payments out back to you because you'll be in a lower tax bracket in retirement so try and stretch that out as much as possible. You add that on top of railroad retirement and a pension, happy days, so to speak. That's really important to figure out how you want to strategize to take those deferred payments once in retirement.
Then finally, how should you invest in the deferred compensation? You can invest that money. Normally, similar to what you can in a 401k, the 20 or 25 funds. It is important to remember though, I didn't really put this up here because railroads to me are very, very safe investments. Remember, with deferred compensation, that's not your money, that's the company's money. If something were to happen to the company like go bankrupt or something, you'd be a creditor perhaps to the company and that's not really your money so that would be a bit of a risk. I would say that's a risk for different types of companies, but class one railroads for the most part or the larger short lines, I really wouldn't worry about that so much, but you should be made aware that it isn't technically your money yet because you haven't paid taxes on it, and it's not in your account, so to speak, but you can invest it.
I hope you found this helpful. Like I said, good primer on the deferred compensation, big part of building a great retirement strategy, railroad retirement strategy. If you need help with this and you're at or near retirement and you want to understand deferred compensation, reach out to me. We can go through a little bit more, see how it all plugs into your retirement, all right.
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Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. Highball Advisors encourages you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Highball Advisors, and all rights are reserved from Highball Advisors, and all rights are reserved.