(Dow Jones) Financial advisors and their executive clients have had some difficult guesswork to do this year in deciding how much of their 2010 year-end bonuses to tax-defer, and for how long to do it.
Last year, many of the executives lucky enough to receive a bonus took the cash because they were worried about job loss and company bankruptcy. This year, some advisors are encouraging clients to defer more-as much as they can, in fact-because of rising taxes and shrinking pension benefits.
"If you could afford the deferral, I would be focusing on it now more than ever," said Robert Barbetti, a managing director at JPMorgan Private Bank.
Barbetti said deferring works best if clients wait at least eight years to take a distribution. "If I deferred at least 10 years with a pre-tax 8% return, I could afford a 53% combined federal and state income tax," he said.
Top managers at many firms, typically those earning more than $250,000, have until June 30,to decide how much or how little they want to voluntarily defer of their 2010 performance bonus even though they don't yet know how much they'll receive. (They usually decide by December 31 how much of their fixed salary to defer.)
They also get to decide when to take a distribution. Many schedule a distribution when junior starts college or after they've retired (and perhaps moved to a state with low or no income tax like Florida.)
Most bonuses are paid in the first quarter of the next year. And with taxes rising for income received in 2011, there is an incentive to defer. For those who get their bonuses in December, before tax hikes take effect, there may be a reason to take the money and pay taxes now. Income tax in the top bracket is currently scheduled to rise from 35% to 39.6%. Those earning more than $250,000 face even higher taxes after 2013 when healthcare-related taxes go into effect.
But there are lots of other considerations, such as a company's likelihood of insolvency-deferred compensation isn't guaranteed if a company fails.
Doug Frederick, who leads Mercer's national Executive Benefits Group, encourages financial advisers and their clients to do some "What if scenarios?" before deciding how much to set aside and for how long: What if the company went into bankruptcy, what if tax rates increase, what if someone needs the money sooner rather than later?
He says advisors and their clients also need to consider investment options within the plan.