If you dream of retiring early, it’s definitely possible – though not without plenty of advance planning and saving.
One roadblock you’ll have to plan for is that you won’t have access to Medicare until you hit full retirement age, which is 65 for most people.
So, what should you do until then? When I have clients who plan to retire early, one option we talk about is using a deferred compensation plan to hold them over until full retirement age.
What is a Deferred Compensation Plan?
This plan allows an employee to put off accepting some income until a future date.
For example, you might take $50k of your annual income and defer it until you reach age 55, or whenever you plan to retire. If you’re 45, that means that for the next 10 years you’ll be putting $50,000 aside annually, and accessing it once you retire.
The money you put aside can earn a return until whenever they are paid out. As for taxes, you’ll pay social security and medicare on those funds every year, but you won’t pay income tax (if you’re required to do so) until you actually receive the deferred money.
Bonus: A deferred compensation plan will help you reduce your taxable income during the deferral period. And when you do actually receive that money in retirement, it will likely be in a lower tax bracket, so you’ll reduce your tax burden then, too.
How is a Deferred Compensation Plan Different from a 401(k)?
The biggest difference between a deferred compensation plan and a 401(k) is that you can put significantly more money aside with a deferred compensation plan. When you defer your income, you can put aside up to 50% of whatever you earn each year.
401(k)s, however, are limited. For 2019, you can put aside up to $19,000 in a 401(k), or $25,000 if you’re age 50 or above. If you’re a high-income earner, you’ll need to supplement those 401(k) savings with something else to prepare for retirement.
What are the Downsides?
Since technically the money isn’t yours until you receive it, there are a couple of risks. If your company were to claim bankruptcy or get sold they do not have an obligation to pay. That’s why it is important to review your plan documents. Someone closer to their desired retirement date has a lower risk than someone younger.
Another downside of opting for a deferred compensation plan is that it is very limited in terms of liquidity. Accessing those funds before the deferral period is up is going to be very difficult.
The age at which you can start receiving your deferred compensation is not changeable. Whatever you decide when you set up the plan is what it will stay for many plans. So think carefully about when you want to start receiving that money and make sure you can safely put it away until that time.
Do you need help preparing for retirement? Contact me today to set up an initial meeting.