Why a form that arrives every fall may be the most valuable tax decision of Michael’s final three working years

Who Michael Is

Michael is 54, a VP at a large public tech company in the South Bay, three years from the retirement date he’s quietly circled. His base salary is $425,000. His target bonus is around $150,000. RSUs vest at roughly $600,000 a year. He maxes his 401(k) every January without thinking. By almost any measure, he’s done the work.

Every fall, an email arrives from the benefits team about the nonqualified deferred compensation plan. And every fall, Michael closes it. It looks like more paperwork. He assumes it’s a slightly fancier version of the 401(k), and he’s already doing that.

That assumption is expensive.

The Problem Hiding in Plain Sight

Start with the tax picture. At Michael’s income, his combined federal and state marginal rate, plus Medicare surtaxes, approaches 50%. Every additional dollar of salary or bonus he earns in these last three years is taxed at the highest rate he will likely ever pay.

His 401(k) barely dents that. The 2026 employee deferral limit is $24,500. His $8,000 catch-up doesn’t reduce his taxes anymore either. Under SECURE 2.0, anyone with more than $150,000 in prior-year FICA wages from their employer must now make catch-up contributions as Roth. So on more than half a million dollars of cash compensation, Michael’s pre-tax shelter through the 401(k) is under $25,000.

Then there’s the match he doesn’t know he’s missing. The IRS caps the compensation a 401(k) plan can count at $360,000 for 2026. Michael’s employer matches, but only on pay up to that line. Every dollar he earns above it generates no match at all.

The highest earners in the building get the smallest percentage benefit from the 401(k). Deferred comp plans exist precisely to close that gap.

What We Uncovered

The benefits portal summary makes these plans look interchangeable. The actual plan document tells a very different story, and in Michael’s case, three things stood out.

The deferral capacity. The plan allows participants to defer up to 50% of base salary and up to 100% of bonus. That’s real room. Michael could move $200,000 a year out of a near-50% bracket, compared to $24,500 through the 401(k).

The match. Like many large-company plans, Michael’s includes a restoration contribution. The employer credits the match he would have received on compensation above the $360,000 cap, but only if he defers into the NQDC plan. If he doesn’t enroll, that money never shows up. Not every plan offers this, and vesting schedules vary. When it’s there, though, skipping enrollment means leaving compensation on the table.

The distribution election. This is the piece most people miss. Michael has to decide how he’ll be paid out at the same moment he decides to defer, and that decision matters more than it would in a 401(k) for one simple reason.

Deferred comp can’t be rolled into an IRA. It isn’t a qualified retirement plan, so the tax deferral ends the moment the money is paid. Whatever Michael receives is taxed as ordinary income that year, and what’s left lands in his bank account as after-tax cash. From there, it can go into a brokerage account, but it will never be tax-deferred again.

There is no rollover. When deferred comp pays out, the tax deferral is over, which makes the payout schedule the entire tax strategy.

Picture Michael’s projected balance of roughly $700,000 paid out as a lump sum when he retires. Three things happen at once.

It stacks on top of his final year. His last salary, bonus, and RSU vests are already in that year’s income. The lump sum sits on top of all of it, so most of it is taxed at the top federal bracket, plus state tax. That’s the very rate he deferred to avoid.

The withholding comes up short. Employers typically withhold a flat 22% federal rate on supplemental payments under $1 million. His actual rate on those dollars could be 35% to 37%. The difference arrives as a large bill in April, and possibly an underpayment penalty, unless he plans estimated payments in advance.

The growth becomes taxable. Inside the plan, the balance grows tax-deferred. Once it’s sitting in a brokerage account, dividends, interest, and realized gains are taxed every year.

The alternative: ten annual installments. Instead of taking everything at once, Michael can elect to receive his balance in equal payments spread over ten years. On a $700,000 balance, that’s roughly $70,000 a year. This choice changes the math and answers each of the lump sum’s problems directly.

Each payment lands in a year when his paycheck is gone, so it’s taxed in far lower brackets instead of stacking on top of his peak earnings. Smaller, predictable payments make withholding simple to plan around, so there’s no April surprise. And the portion not yet paid out keeps growing tax-deferred inside the plan for up to a decade longer.

A lump sum ends the tax deferral in a single year, at the highest rate. Ten installments spread it across a decade of lower brackets.

Installments carry one more advantage, and for readers in high-tax states it can be the biggest one. With a lump sum, the state where Michael earned the money keeps its claim on it no matter where he lives. A federal law, 4 U.S.C. §114, prohibits states from taxing nonresidents on certain retirement income, including nonqualified deferred compensation paid in substantially equal periodic installments over at least 10 years. If Michael elects ten annual installments and later retires to a state with no income tax, the state where he earned the money can’t tax those payments.

The Risks We Didn’t Ignore

Deferred comp is not free money. This is where the conversation has to be honest.

The balance isn’t held in a trust in Michael’s name. It’s an unfunded promise from his employer. If the company runs into serious financial trouble, he stands in line with other unsecured creditors. For someone whose net worth is already concentrated in that same company’s stock, that’s double exposure to one balance sheet. I don’t wave that away.

The rules are also strict. They come from a section of the tax code called 409A, which you may hear your benefits team mention. In plain terms, they work like this:

You decide before you earn it. You generally have to make the election to defer next year’s pay by the end of this year. That’s why enrollment windows open in the fall, and why missing one means waiting a full year.

You can’t take it out early on demand. The money pays out on the schedule you chose when you enrolled, not when you happen to want it.

Changing your mind is slow. To push a payout later, you must request the change at least a year ahead, and the new start date must be at least five years after the original. You generally can’t speed payments up at all.

Senior officers wait six months. At a public company, top executives usually can’t receive payments tied to leaving until six months after their last day.

None of that is a dealbreaker. These are design constraints, and the plan has to be built around them, not discovered after the fact.

The Plan We Built

We sized Michael’s deferral at roughly $200,000 a year for each of his remaining three years, weighted heavily toward bonus with a portion of base. That keeps his take-home pay comfortable while pulling the most heavily taxed dollars out of his peak years.

We elected ten annual installments beginning after separation. With the restoration match and modest notional growth, that projects to roughly $70,000 a year, landing between ages 58 and 67.

Then we fit it into everything else. Those installments arrive before Social Security at 70 and before RMDs begin at 75. That’s useful bridge income, but it also occupies some of the low-bracket room we’d otherwise use for Roth conversions. So we modeled the installments and the conversion schedule together, sizing each year’s conversion so the two don’t collide and push him into a bracket we were trying to avoid.

The timing also works in Michael’s favor in another way. Money in an IRA generally can’t come out before age 59½ without a 10% penalty, and the 401(k)’s age-55 exception applies only to that one plan. Deferred comp has no age rule at all. It isn’t a qualified retirement plan, so there’s no early-withdrawal penalty. Payments simply start when the plan says they start. For Michael, retiring at 57 means income from day one of retirement without touching his IRAs or paying a penalty to access them.

What Changed

Michael moves roughly $600,000 of compensation out of the highest-taxed years of his life. Those dollars get taxed later, in years when his income and bracket are meaningfully lower. If he retires to a state without an income tax, the installments escape state tax entirely. And he has penalty-free income starting at 58, well before 59½. He captures a restoration match he’d been forfeiting for years.

The email he’d been closing every fall turned out to be one of the most consequential decisions of his final working years.

If This Sounds Familiar

If you’re a senior leader at a tech company and that enrollment email is sitting in your inbox right now, read the plan document before the window closes. Look for three things: how much you can defer, whether an employer contribution is attached, and what your distribution options are. The deferral decision and the payout decision are really one decision, and both belong inside your full retirement picture, not next to it.

If you’d like a second set of eyes on how deferred comp fits your plan, I’m glad to talk it through. Reach me at Randa@RadiantWealthPlanning.com.

These stories are based on real-life scenarios. Names and details have been changed. This content is for educational purposes only and does not constitute financial, tax, or legal advice.