What is the Microsoft Deferred Compensation Plan?

Reduce Your Tax Bill Utilizing Microsoft DCP (Deferred Comp Plan)

The Microsoft Deferred Compensation Plan (DCP) is available to employees who are Level 67 and higher. Eligible Microsoft employees can enroll annually during May and November.

Your DCP contributions reduce taxable income in the year of the deferral.

Many employees are able to reduce their tax bill by tens of thousands of dollars. Deferred Compensation is a chance to save and invest dollars on a pre-tax basis, like your Microsoft 401(k). Contributions to your DCP can be invested into a selection of investment options.

“You can defer up to 75% of next year’s salary as a Level 67+ employee,” explains Dave Welty, Co-Managing Director at Avier Advisors. “DCP can potentially help you reduce next year’s tax bill by north of $100,000. This can literally help change the financial trajectory of your life.”

When Can You Enroll in Microsoft DCP?

There are only two times a year to enroll in DCP.

Both enrollment windows impact the next calendar year’s compensation.

May 1 – 31
Elect to defer up to 100% of next year’s bonus

November 1 – 30
Elect to defer up to 75% of your salary

If you choose to defer a portion or all your bonus, you will see this deduction when your bonus is paid out on September 15th following the end of upcoming fiscal year.This means you make the decision to defer your bonus about 16 months before you receive it.

Salary deferrals will start on January 1st and end on December 31st of the next calendar year.

Schedule a Deferred Compensation Consultation

There is a significant amount of planning that is needed when deciding to enroll in DCP.

You need to ensure your money comes out on time, at the right time, and in amounts that make sense for you.

During this 30-minute call we will discuss:

• Strategies for reducing your taxable income.
• Maintaining cashflow to cover monthly expenses.
• Developing a comprehensive payout strategy.

Key Differences Between Microsoft DCP and Your 401(k)

Like your 401(k), the Microsoft DCP is a vehicle to help defer taxable income and reduce current tax liabilities. However, there are some key differences you should be aware of:

Microsoft DCP Considerations

Decide How Much Income to Defer

Microsoft employees are compensated in three ways: salary, cash bonuses, and stock awards.

Salary and Cash Bonuses

By utilizing DCP, you can control the percentage of salary and cash bonus that is taxed each year, significantly reducing your total taxable income. You decide when these deferrals are paid out to you and can maximize the benefit by having payouts occur when you are in a lower marginal tax bracket, most often in retirement.

Stock Awards

You have no control, from a timing or tax perspective, when it comes to your vesting shares. The market value on the day of the vest is recorded as income and taxed at ordinary income rates, regardless of if you sell or hold on to the shares.

Your RSUs vest multiple times per year and typically vary in amount each vest. Functionally, at the time of vest, it’s as if you were given cash and decided to use every dollar to purchase Microsoft stock.

While RSUs cannot be deferred under Microsoft’s Deferred Compensation Plan, it’s worth noting that certain other types of equity awards may qualify for deferral depending on how they are structured. Understanding which awards are eligible and how they interact with your overall deferral strategy is an important piece of long-term planning.

We encourage you to defer as much of your salary and bonus as possible.

This can help you reduce taxable income. It also means you will reduce your income stream.  “DCP at Microsoft is more than a benefit – it’s a financial game-changer. By strategically deferring income, we’re not just potentially reducing next year’s tax bill by upwards of $50k-$100k, we’re reshaping your financial future,” says Welty.

To supplement your deferred income, we recommend you sell your RSUs as they vest and use the proceeds to help fund your cash flow.

There are a couple of reasons this strategy can be beneficial:

• Your Deferred Comp is invested in diversified investments, so rather than keeping your money tied up in Microsoft stock, you can broaden your portfolio.
• Once you’ve cashed out your RSUs, you can use any proceeds to cover living expenses or re-invest these dollars in a regular brokerage account.

Decide When to Receive Your DCP Distributions

Deferred Compensation is different than a 401(k) where you’re able to withdraw money early (with penalty) or wait until retirement to withdraw funds until they are depleted.

DCP requires more advanced planning. For each deferral (each year that you defer salary/bonus), you must decide when you want to start receiving your money and over what time frame.

Typically, you choose either a lump sum or to receive it over a 3-15-year installment plan.

As money is distributed, you are taxed. It’s important that you consider how much in taxes you’re willing to pay each year after your withdrawal begins and to structure the payouts accordingly.

Investment Options Within DCP

There are 24 different investment options with DCP, the options are similar to what you have with your 401(k). You will select your investment allocation at the time you make the deferral.

You can make changes to how your dollars are invested at any time and have flexibility when deciding how to invest those dollars.

In our opinion, the investment options within DCP are more robust than what you will find within your 401(k). The BrokerageLink option is not available within DCP.

The dollars that you defer are not actually invested into the funds that you choose – Instead, Microsoft tracks the performance of your selected investment options and assumes the risk to pay out your contributions and the assumed earnings.

State Tax Planning

State tax treatment is an often-overlooked aspect of DCP planning. Distributions scheduled for nine years or less are generally taxed in the state where the income was earned.

By contrast, if distributions are spread over ten years or more, taxation is typically determined by the state of residence at the time of payment. For employees planning to move from a high-tax state such as California to a state with no income tax like Washington, this can create meaningful long-term savings opportunities.

Changing Microsoft DCP Elections

Employees can change their distribution elections, but there are specific rules to keep in mind. Any change must push the distribution back at least five years from the original schedule, and the change must be made at least 12 months before the original payout date.

Additionally, if an employee separates from Microsoft earlier than expected, the election may revert to the original distribution schedule. Being aware of these mechanics is key to building flexibility into your deferral strategy.

Should You Enroll in the Microsoft Deferred Compensation Plan?

If you are eligible, the Microsoft Deferred Compensation Plan is a great benefit that can help you reduce your tax bill by thousands, however, it is also one of the most complicated to implement and manage.

It requires careful planning and monitoring to ensure current and future cash needs are met with considerations in place to reduce future tax liabilities.

Risks Associated with Microsoft DCP

Balances in Microsoft’s DCP are considered unsecured obligations of the company. This means that participants are subject to the credit risk of Microsoft – in other words, if the company were ever to face financial difficulties, deferred balances could be at risk. While this outcome is unlikely for a company of Microsoft’s financial strength, it is important to acknowledge the nature of this risk.

Other Microsoft Benefits

DCP decisions don’t exist in a vacuum; they interact with other benefits available to Microsoft employees. Microsoft matches 50¢ on every $1 you contribute to the 401(k), up to the annual IRS elective deferral limit for employees under age 50. Employees may also take advantage of Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs) for additional tax savings.

Microsoft offers a mega backdoor Roth feature for expanded retirement contributions, and employees can also participate in the Employee Stock Purchase Plan (ESPP), which has contribution caps that may be affected by large deferrals. Reviewing these benefits together provides a more holistic view of your financial strategy.

Personal Budget Considerations

Deferring part of your paycheck can be a smart move for long-term tax savings, but it definitely changes what hits your bank account today. If you choose to defer something big – say 75% of your salary – your take-home pay is going to feel a lot smaller. With less in your paycheck, you might find it tougher to contribute to your ESPP or max out your 401(k), which should be prioritized due to Microsoft’s company match.

With all this saving, it’s still important to maintain enough current income to meet expenses and stay financially flexible.

Schedule a Deferred Compensation Consultation

During this 30-minute call we will discuss:

• Strategies for reducing your taxable income.
• Maintaining cashflow to cover monthly expenses.
• Developing a comprehensive payout strategy.