Everything You Need to Know About Microsoft Deferred Compensation Plans
Working at a well-known company like Microsoft is a dream come true for many. For employees of the tech giant, you’ll find there are TONS of perks to make the most of your salary, such as the deferred compensation plan (sometimes referred to as the Microsoft DCP).
This feature is available for employees at Level 67 or higher, but how does it work? Let’s dive into what it is and how it all works.
What is Microsoft’s Deferred Compensation Plan?
The Microsoft Deferred Compensation Plan allows you to defer some of your taxable income (such as base salary, bonus, or certain equity awards) in the year you receive it to a year in the future.
The general idea is that you’ll defer income in a high tax year to be received in a lower tax year. This can be a strategic tax planning move for high-income earners!
Microsoft employees often choose to defer payment until retirement, but this will depend on your financial situation and plans for the future.
Contributions to the DCP are tax-deductible, invested, and then taxed upon withdrawal years in the future. By investing the funds, you may also earn a return along the way!
What are the Benefits of Microsoft's Deferred Compensation Plan?
If you qualify for the Microsoft DCP, you’re likely wondering whether or not it makes sense to enroll in this program. At a glance, taking money away from your annual salary or bonus may not be the move you want to make. Isn’t it better to keep more money in your pocket or savings account instead of deferring your salary?
The answer is a bit more complex than a simple yes or no. First, you must consider whether your salary is going to ultimately put you in a higher tax bracket at the end of the year. If you believe that you will owe lots of money to the IRS at the end of the fiscal year, it might be a savvy move to eliminate some of that taxable income in the current tax year.
Instead, this money can be withdrawn from the DCP years down the road when you may be in a lower tax bracket (like during retirement).
Contributions made to the Microsoft Deferred Compensation Plan are invested. They are composed of two separate parts of your income and have two separate enrollment periods. It’s important to take these windows into account by planning ahead.
Here’s a quick breakdown of these two parts:
The first portion of the DCP election is how much, if any, of your annual cash bonus will be contributed to this plan. The enrollment window opens in May and is only for the following year's bonus. This means that an election in May of 2024 won’t actually occur until September of 2025 – you're making a cash flow decision 16 months in advance! You can elect up to 100% of your cash bonus to be deferred to the DCP.
The second portion of the DCP election is very similar to a 401(k) contribution in that it’s a direct deduction against your salary. The enrollment period happens every November and will go into effect in January for the calendar year. The max deferral limit for your salary is 75%.
Who Can Enroll in Microsoft DCP?
Unfortunately, not all Microsoft employees qualify for DCP contributions. These are only available to employees who have reached Level 67 or higher.
You also must make sure that you register for this plan during the enrollment period. Enrollment windows are only open for 1 month for each election each year.
As mentioned above, the enrollment window varies depending on the type of deferral:
Salary deferral window: November 1st to November 30th
Bonus election deferral window: May 1st to May 31st
If you miss your enrollment window, you will have to wait until the following year to make elections for future salary/bonus.
Distribution Options
Aside from how much to defer into DCP, during your enrollment window, you’ll also have to decide when and how to receive the funds in the future.
This can be a difficult decision, as not everyone knows what their income situation will look like 10 to 15+ years from now. This money will sit in the investment account for varying lengths of time depending on which election you make.
Here are your options:
“At Termination” - This is the default election if you don’t make one
Selecting a specific month & year
Annual payments of 5, 10, or 15 years
If you have worked for Microsoft for many years and made multiple DCP elections, it’s essential to think about what will happen if you elect the “lump sum at termination” option. For example, if you leave Microsoft but still plan to have a high amount of income, the last thing you want is one large paycheck that you’ll be forced to pay income taxes on immediately.
On the other hand, if you spread your election out over 10 years, you could effectively take 10% of your initial contribution (plus growth) out over that 10-year time frame. This could potentially be a nice way to replace your paycheck in retirement if planned properly.
Pro Planning Tip: If your election is 9 years or under, your payouts will be taxed based on the state you worked in, not the state you live in. If your career with Microsoft was in Washington state, they currently don’t have an income tax. If you retire in California and elect a distribution of 10 years or more, your DCP payouts will be subject to California income tax.
However, if you worked in Washington, retired in California, and took a payout of 9 years or less, this income would not be subject to California state income tax. Of course, in all cases, this income will be subject to federal income tax.
What to Consider Before Enrolling in Microsoft DCP
Microsoft DCP can be a powerful part of your personal tax plan, but it’s not the right move for everyone. Before you dive in, here are some factors to consider in your decision.
Making Changes to Your Election
Make sure that you are clear about when distributions will be made on these investments prior to setting aside some of your salary or bonuses. Having a DCP is a special benefit subject to its own IRS rules, and comes with some nuance.
For example, if you decide to change a distribution election that you previously made, you have to push the distribution date back by a minimum of 5 years! The change in distribution election also has to be made at least 12 months prior to the scheduled distribution date while an active employee.
In other words, if you change your election and leave Microsoft 6 months later, it will revert back to your initial election.
Risks of Microsoft DCP
Lastly, take note that participating in the DCP is subject to credit risk of Microsoft. You’re essentially asking Microsoft to not pay you compensation today, and instead to “defer” that compensation into a future year. If Microsoft isn’t in business in that future year, there is no guarantee the compensation inside of this plan will be paid to you. This is different from funds inside of a 401(k) plan, which is held in a separate trust, not subject to creditors of a company.
If you are thinking about making the most of your employment at Microsoft, the DCP might be a good fit for you. However, there are a few other financially savvy moves that you may want to consider before you elect to defer a portion of your salary or bonuses into the Microsoft Deferred Compensation Plan.
This article is just meant to scratch the surface of the most common DCP questions. For more details on how the DCP fits into your financial plan, consider reaching out to us for help.
Other Microsoft Benefits
Before enrolling in Microsoft DCP, make good use of all your other Microsoft benefits. This means maxing out your Microsoft 401(k), health savings account (HSA), or flexible spending account (FSA) first. All of these investments yield their own tax benefits. For example, an HSA allows you to contribute pre-tax dollars with tax-free withdrawals for healthcare spending.
A 401(k) plan also takes money directly out of your paycheck before income taxes are deducted. This means that it effectively lowers your taxable income, just like the Microsoft DCP. Instead, you will pay taxes on those funds when you withdraw them in retirement and are likely in a much lower tax bracket.
Microsoft also offers a mega back-door Roth 401(k) by contributing to the after-tax portion of your 401(k) and subsequently making the “convert my after-tax to Roth” election on NetBenefits on the contributions screen. In 2024, this is an additional $34,500 that can be contributed to your 401(k) and grow tax-free for the rest of your life.
Your 401(k) contributions at Microsoft will also be matched 50 cents on the dollar, up to the IRS limit. If you are contributing the maximum amount to your Microsoft 401(k), Microsoft will make a 50% contribution (up to $11,500 in 2024). This “free” money can help to fund your retirement! Always take advantage of this option before deferring money through the Microsoft DCP.
Current Budget
Another thing to consider is your current monthly budget. If you decide to contribute the full 75% of your base salary to the DCP, your expected paycheck amount will significantly decrease.
Your Microsoft ESPP (Employee Stock Purchase Program) maximum is 15% or $25k annually, whichever is less. So if you defer a high amount into the DCP, you run the risk of not being able to max your Microsoft ESPP and/or not being able to max the 401(k) to receive the full amount of matching funds!
Make sure that you pay close attention to your budget or consider meeting with a financial advisor to make sure your regular paycheck will still be able to fund your lifestyle.
Get the Most out of Microsoft DCP
Managing your finances or portfolio can be complex, especially when you start juggling DCP into the mix of Microsoft RSUs, 401(k)s, HSAs, charitable giving goals, and any other types of investments that you may have. We have an extensive library of resources for Microsoft employees aiming to make the most of their benefits — check it out for FREE!
Beyond your own efforts, one of the best things you can do to optimize your compensation is to work with experts to understand the best path forward.
Consilio Wealth Advisors eliminates the jargon so you can make financial decisions with confidence. We take the time to understand your financial goals and help you make them happen. If you need help with your Microsoft benefits, reach out to us to learn more about how we can help you manage your money now.
Disclosures
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
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