A Roth IRA can be seen as an every man’s investment plan. A deferred compensation plan, for the most part, is the domain of company brass. The reason why has to do with contribution limits. A Roth IRA has contribution rates in the single thousands while the contribution limits of deferred compensation plans are, for the most part, limitless. These plans are for people looking for a place to invest money above and beyond what they need to live during their working years.
A Roth IRA is an individual retirement account. It allows savers who meet certain income requirements to contribute up to $5,500 annually, the new amount as of 2013. The funds going into the account come from post-tax income. For instance, you are likely taking money out your regular paycheck to make contributions. Thus, that money has already been taxed. This means the money taken out of the account once you retire is tax free. There are eligibility requirements to establish a Roth IRA. An individual with an income of more than $110,000 is ineligible. A married couple must have a household income of less than $173,000.
Deferred compensation plans are offered by employers. They allow an employee to take out a piece of their paycheck, whether it’s from a salary or bonus, and place it in an account they can draw on at a later date. They are often used as retirement accounts. Funds for these plans are taken out of a salary tax free. The employee will only have to pay taxes when they are withdrawn. These describe the qualities of a non-qualified deferred compensation plan. A qualified deferred compensation plan, on the other hand, does allow benefits to grow tax-deferred and they can be rolled over into an IRA. According to an article in the "New York Times," deferred compensation plans are normally used by only the top 5 to 10 percent of earners in a company.
Pros and Cons of Deferred Compensation
Taxes can be your friend or foe with deferred compensation. A high earner may be in a higher tax bracket than the one they expect to be in upon retirement, for instance. Therefore, if tax-free money can be put aside in a deferred compensation account when you are in a high tax bracket then it’s likely you have to pay less money to Uncle Sam when the money is taken out. The opposite is true as well. Since there are no limits to how much can be put into these accounts, deferred compensation can result in a hefty nest egg. But a word of caution, in the case of company bankruptcy creditors could go after a deferred compensation account leaving an employee with nothing.
Pros and Cons of a Roth IRA
The individual nature of the Roth IRA protects the accounts from company troubles. The Federal Deposit Insurance Corporation covers up to $250,000 worth of Roth IRAs owned by one person at a single bank or other financial institution. You are also in charge of the plan and are given more investment choices than say a company 401(k). One of its drawbacks, however, is in the amount of money that can be contributed per year. Those fortunate enough to have more than $5,500 to invest in a year need other options for the rest of the cash.
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