At 66 With $1.1 Million, He’ll Start Collecting From His Old Company’s Deferred Compensation Plan. The Payout Schedule He Picked Years Ago Decides His Tax Bill

His first deferred compensation statement since retiring just arrived. He’s 66, has $1.1 million in other retirement savings, and the statement shows a plan balance that, for this example, we’ll set at $600,000. It’s built from portions of bonus he deferred year after year. It also shows the payout schedule he picked when he deferred that money, and that schedule now controls how much the IRS takes.

Plenty of retired managers and executives end up here. They read the payout election closely for the first time only when the checks are about to start.

How a Deferred Comp Plan Differs From a 401(k)

A 401(k) holds your money in a trust in your name. A nonqualified deferred compensation plan (NQDC) is just a promise from the company to pay you later. Treasury rules describe this kind of promise as “an unfunded and unsecured promise to pay money“ (26 CFR 1.83-3(e)^[1]). Put simply, if his old employer goes bankrupt, he’s one more unsecured creditor waiting in line with everyone else the company owes.

Four rules shape what he can do:

1. Taxed when paid. The amount he deferred “isn’t included in your income” in the year he deferred it, per the IRS (Publication 525). Each payout gets taxed as ordinary income when it lands.
2. Payroll taxes already covered. Social Security and Medicare taxes generally hit the money when he earned it or when it vested, whichever came later, and the law says it’s “taxed only once” (26 U.S.C. § 3121(v)(2)^[2]).
3. No IRA rollover. A rollover has to come from “a qualified trust” (26 U.S.C. § 402(c)(4)^[3]). An NQDC plan isn’t one.
4. Changes are nearly impossible. A new election can’t take effect for 12 months^[4]. It has to push the payment back at least 5 years^[4], and for payments set for a fixed date, it has to be made at least 12 months before the first one (26 U.S.C. § 409A(a)(4)(C)). Once payouts are about to start, he’s basically locked in.

One Check or Ten: What the 2026 Brackets Do

Let’s establish the assumptions, as he’s married and files jointly. The couple receives $50,000 a year in Social Security, has no other income, and the balance doesn’t grow. The tax brackets stay at 2026 levels.

With a lump sum, his income for Medicare purposes rises to $642,500, and 85% of his Social Security becomes taxable. After the standard deduction and the additional deduction for his age, part of the payout lands in the 35% bracket, which starts above $512,450. Federal tax comes to about $150,566.

Consider ten installments of $60,000, but only $40,850 of Social Security is taxable each year. Before age-based deductions, taxable income is $68,650. After those deductions, federal tax is about $6,824 annually through 2028 and $7,544 thereafter, or $73,300 over ten years. In the lump-sum version, the nine quiet years cost nothing, because his Social Security alone stays under the $32,000^[5] joint threshold. Even so, installments come out about $74,000 ahead.

Medicare adds to the gap. Its income-based surcharges, called IRMAA, look at your tax return from two years prior. The lump sum lands in the joint level above $410,000^[6]. That puts Part B at $649.20^[6] a month instead of $202.90, plus $83.30 for Part D. For a couple, that’s about $12,700 extra for the year. The installment years stay under the $218,000^[6] threshold.

Ten Years Also Shields Him From His Old State

Federal law bars states from taxing former residents on deferred comp paid in substantially equal payments, at least once a year, over his life expectancy or “a period of not less than 10 years” (4 U.S.C. § 114(b)(1)(I)). A separate exception covers plans that exist only to pay benefits above the 401(k) limits. Under the general rule, a nine-year schedule doesn’t qualify. If he’s leaving a high-tax state, the length of his schedule determines whether that state can still tax these checks.

Planning Around the Schedule He Already Picked

If he selected installments, leave room under them. He was born in 1960, so his IRA withdrawals aren’t required until age 75, starting in 2035. Between now and then, he can take small IRA withdrawals or do Roth conversions up to the top of the 12% bracket at $100,800. The last few installments will overlap with his required withdrawals, so shrinking the IRA now pays off later.

If he selected a lump sum, keep that year clean. Skip IRA withdrawals and live on cash. Then use the nine empty years that follow for Roth conversions out of the $1.1 million before required withdrawals begin. That window between the last paycheck and the first RMD may be the lowest tax rate he ever sees again, and we sized up how to use it in a free guide here. That recovers part of the cost. The one solid reason to want a quick payout is worry about the company’s finances, since he’s an unsecured creditor.

Find the Original Distribution Election Form

Dig out the election form he signed when he first deferred the money. It shows what starts the payments (leaving the company or a set date), whether he selected a lump sum or installments, and whether the schedule runs at least 10 years. It also tells him if the 12-month and 5-year rules leave any chance to change it. A plan that held several years of bonus deferrals may have a separate election for each year.

The most common mistake is piling IRA withdrawals or Roth conversions on top of a big deferred comp year. That pushes income into the 32% and 35% brackets and sets off Medicare surcharges two years later.

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