Many successful executives are enrolled in their employer’s traditional 401(k) plan and their deferred compensation (“deferred comp”) plan.
Your employer’s traditional 401(k) plan and deferred comp plan may look similar. They may be visible from the same website and they may appear to have the same investments, but they are different in one very critical way. The deferred comp plan is not protected if your employer goes bankrupt, while the 401(k) plan is protected.
With the recent downturn in the markets and volatility likely to continue, it’s important that you understand the differences between the two types of employer plans and review if any adjustments need to be made to your participation or allocation strategy.
401(k) Plan vs. Deferred Compensation
The 401(k) plan assets are an ERISA (Employee Retirement Income Security Act) retirement account that are often invested exclusively in mutual funds selected for your 401(k). According to ERISA law, your employer must keep the 401(k) funds separate from the company’s assets, so in the case of an insolvency, your interest is protected, and the business’ creditors have no access to it.
A deferred comp plan is simply an “I Owe You” (IOU) from your employer to you. This is essentially a documented promise from your employer to pay you the deferred balance (plus any earnings) in the future. Unlike your investments within a 401(k) plan, a deferred comp plan is not covered by ERISA rules and thus you are a creditor of your employer for that balance.
This means that if anything happens to your employer – for example, if they declare bankruptcy the balance in your deferred compensation account would be at significant risk.
Review Your Deferred Compensation
If you or your loved ones are currently participating in a deferred compensation plan, we recommend that you review the plan and revisit your strategy every few years. With industries and companies more vulnerable due to the current crisis, it may be even more prudent to ask yourself the following questions:
Will my employer likely to continue to survive harsh times or is my deferred compensation balance at risk?
How much have I added to the account over time?
How much do I plan to add to the account over time?
Do I still feel comfortable having this IOU from my employer for the long-term?
Do I need to reduce my risk to my employer’s balance sheet?
Executive compensation can bring a level of complexity to your financial situation. Your Modera team is here to help empower you to make smart financial decisions. Please do not hesitate to reach out to us if you have questions.
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