How a 10-Year Payout Can Maximize Tax Efficiency in Retirement
For high-income earners, especially executives and professionals in high-tax states like
- California (13.3%)
- Hawaii (11%)
- New Jersey (10.75%)
- Oregon (9.9%)
- Minnesota (9.85%)
- District of Columbia (8.95%)
- New York (8.82%)
- Vermont (8.75%)
- Iowa (8.53%)
- Wisconsin (7.65%)
Deferred compensation plans are a powerful tool for both retirement planning and tax management. But the benefits extend beyond simply deferring income into future years when your tax bracket might be lower — they can also play a strategic role in reducing or even eliminating state income tax liability, depending on where you reside at the time of payout.
This article explores the advantages of electing a 10-year payout option on deferred compensation plans, particularly when relocating to a state with no income tax, such as Florida, and how it can significantly reduce your tax burden. I too have benefited from this tax strategy, being a full-time resident, here in Florida.
What Is Deferred Compensation?
A non-qualified deferred compensation (NQDC) plan allows an employee to earn wages in one year but receive the income — and pay taxes on it — in a future year. These plans are often used by executives and highly compensated employees who want to manage their income tax exposure and build future wealth.
Companies typically offer two options:
- Lump-sum distribution (e.g., one-time payment upon retirement)
- Installment payments (e.g., spread over 5 or 10 years)
Why Does the 10-Year Payout Strategy Matter?
The residency rule plays a key role in how deferred compensation is taxed at the state level.
- Federal Taxation: Deferred compensation is always taxed as ordinary income when received, regardless of where you live.
- State Taxation: This is where strategy matters. Under federal law — specifically the 1996 Federal Mobile Workforce Act (and reinforced by case law and IRS guidance) once you’re no longer a resident of a state, that state generally cannot tax deferred compensation paid after your departure, if it’s paid over at least 10 years. Therefore, if you earned deferred compensation while working in New York or New Jersey but relocate to a tax-free state like Florida, and you choose a 10-year payout, your former state cannot tax that income — even though it was earned there.
A Real-World Example
Let’s say:
- You worked in New York for 30 years and earned $2 million in deferred compensation.
- Upon retiring, you relocate to Florida, which has no state income tax.
- You elect a 10-year installment payout, receiving $200,000/year.
Result:
You will pay federal income tax on the $200,000 received annually, but zero state income tax, because:
- You are no longer a New York resident.
- The deferred compensation is spread over at least 10 years.
- Florida does not tax personal income.
Had you chosen a lump-sum distribution while still a New York resident or within a short period after leaving, New York could have taxed the entire amount.
Key Legal Basis: Internal Revenue Code & State Conformity
Federal law (IRC §3121(v)(2)) and state conformity rules generally support the idea that:
- Deferred compensation paid after a bona fide change of residence is not subject to state income tax by the prior state if the payout is over at least 10 years or meets other federal safe harbor conditions.
But timing and documentation are critical:
- Your departure must be legitimate and well-documented.
- The deferral election and payout schedule must comply with IRS and plan rules (including IRC §409A).
- Some states may attempt to assert taxation rights but most fall in line with federal protections if the above conditions are met.
Planning Considerations
- Residency Planning: Establish clear domicile in the new state. Change voter registration, driver’s license, home address, and primary medical providers to your new state before payout begins.
- Coordination with Plan Rules: Most NQDC plans require you to choose a payout schedule at the time you defer the compensation. Make sure the 10-year payout election is made properly.
- Legal & Tax Advisory: Consult a tax advisor and possibly an estate or employment attorney to ensure you’re aligning with federal and state rules.
- Other States to Consider: Besides Florida, other tax-friendly states include Texas, Nevada, Washington, Tennessee, and Wyoming. None impose state income taxes.
Conclusion
A 10-year deferred compensation payout can be a powerful strategy for minimizing your state income tax liability — especially if you’re retiring from a high-tax state and relocating to a tax-free one like Florida. With proper planning and legal compliance, you could potentially save hundreds of thousands of dollars in state taxes.
This is a prime example of how retirement income planning and geographic flexibility can intersect to create significant tax advantages. Over my 40-year career, I've been called the missing advisor. What I find is, we all have insurance, investment, legal and tax advisors and often there is no one coordinating and/or, there's a lack of collaboration amongst the team and I find missed planning opportunities. If you’d like to talk, review your planning & get acquainted, I don’t know what can come from the conversation, feel free to reach out.
Resourcefully yours,
Saul
Source: www.irs.gov
AdTrax 8011921