Deferred bonuses are common in high-level employment contracts.
Proper tax planning is essential for managing large, irregular income payments.
Deferred compensation helps athletes and executives optimize their tax liability.
Taxes
Zoe Team
3 min read
What is a deferred bonus?
A deferred bonus is compensation earned now but paid out in later periods, often to manage tax impacts.
Why do NFL teams use deferred bonuses?
It allows for better cash flow management and helps the organization structure its payroll more effectively.
How does this relate to tax planning?
Deferred payments can help spread income across years, potentially keeping the recipient in a lower tax bracket.
Tom Brady had a big 2017. Not only on the field winning his fourth Super Bowl ring, but off the field as he received a $14 million deferred bonus in addition to his $1 million salary. What is a deferred bonus, you may ask? For NFL teams it is not uncommon to pay out large signing bonus in multiple payments, as it’s a method of cash-flow management. From the player’s perspective, deferred compensation allows you to contribute money from your salary or bonuses to an account where their balances grow on a tax-deferred basis. You don’t pay taxes on the money you defer from your pay, and there are no taxes to pay while it grows. The government shows up only once you withdraw the money.
Image courtesy of Mercury News
In Tom’s case (we are on a first name basis) he made a BIG mistake not deferring his bonus a few months more. Why? With the new tax law that takes effect this year, tax brackets were lowered across the board. Using our Zoe tax calculator I found that Tommy would have received an extra $200,000 (more or less) after tax from that $14 million bonus alone. Just for waiting a few more months to cash the check! To be fair, Tom wasn’t aware of the new tax bill in March of 2017 or I am sure his tax planner would have alerted him to this. I would hope.
Not all firms offer deferred compensation and there are risks associated with the practice. The main one is counterparty risk, which means that if your company is not around by the time you ask for your deferred compensation, you don’t get your money. That may be a significant risk for small organizations, but the larger the employer and the more profitable it is, the smaller the risk of the company not being around the next year to pay you. So for instance, if you are in your 50s and you plan to retire at 60, it can make a huge difference to your tax bill if you defer your annual bonus until after you retire - when your marginal tax rate usually decreases. If you’re a parent expecting to take a few years off to focus on your young children, deferring compensation towards those years can also be an interesting option.
Tom is probably not thinking about this type of personal finance decision right now as he prepares for the big game Sunday, but knowing Tom (ok fine… reading about him) you bet he’s sat down with his wealth manager at some point to ensure that he is strategic about his money decisions with a comprehensive financial plan. Why? Because he understands that just because he’s a master on the field, it doesn’t mean he will have all the answers when it comes to his money, and so he needs help for a professional advisor to serve has his financial quarterback.
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