What Is Deferred Compensation?

Deferred compensation is part of an employee's regular compensation that is set aside to be paid at a later date, usually at retirement. In many cases, taxes on this income are deferred (postponed) until it is paid out. There are many forms of deferred compensation, including 澳洲幸运5官方开奖结果体彩网:retirement plans, 澳洲幸运5官方开奖结果体彩网:pension plans, and 澳洲幸运5官方开奖结果体彩网:stock-option plans.

There are qualified and non-qualified deferred compensation plans. While qualified deferred compensation plans are available to many employees, 澳洲幸运5官方开奖结果体彩网ꦕ:non-qua🐎lified deferred compensation (NQDC) plans cater mainly to 澳洲幸运5官方开奖结果体彩网:high-income earners who want to put away funds for retirement and find the company 澳洲幸运5官方开奖结果体彩网:401(k) plan inadequate for their needs.

How Deferred Compensation Works

An employee may negotiate for deferred compensation because it offers immediate tax benefits. In many cases, the taxes due on the income is deferred until the compensation is paid out, often when the employee reaches retirement age. If employees expect to be in a lower 澳洲幸运5官方开奖结果体彩网:tax bracket when retiring, they have a c💙hance to reduce their tax burden.

澳洲幸运5官方开奖结果体彩网:Roth 401(k)s are an exception, as they require the employee to pay taxes on income as it is earned. The balance in a Roth account is, however, normally tax-free when it is withdrawn. It can be a better option for people who expect to be in a higher ꦬta🐷x bracket when they retire.

Types of Deferred Compensation

There are two br🅷oad categories of deferred compensation: qualified and non-qualified. These differ in their legal treatment and the purpose they serve.

Qualified Deferred Compensation Plans

Qualified deferred compensation plans are governed by the 澳洲幸运5官方开奖结果体彩网:Employee Retirement Income Se♏curity Act (ERISA), a key set of federal regulations for retirement plans. They include 401(k) plans and many 澳洲幸运5官方开奖结果体彩网:403(b) plans.

Funds in qualified deferred compensation plans are for the sole benefit of their recipients. Creditors cannot access the funds if the company goes bankrupt. Contributions to the plans are capped by law.

Non-Qualified Deferred Compensation Plans

Non-qualified deferred compensation (NQDC) plans are contractual agreements between employers and participants. Also known as 澳洲幸运5官方开奖结果体彩网:409(a) plans or, in some cases, 澳洲幸运5官方开奖结果体彩网:golden handcuffs, NQDCs take different forms, including bonus plans, equity (stock) arrangements, and 澳洲幸运5官方开奖结果体彩网:supplemental executive re🔯tirement plans 𒁏(SERPs), otherwise known as "澳洲幸运5官方开奖结果体彩网:top hat plans."

NQDC plans have no caps on contributions and are typically offered only to top-level employees and key talent that the company wants to retain. Independent contractors are eligible for NQDC plans. (This isn't the case with qualified deferred compensation plans.)

Compensation is usually paid out when the employee retires, although there can be provisions for earlier payouts in case of certain events like a change in ownership of the company or a strictly-defined emergency. Depending on the terms of the contract, deferred compensation might be canceled by the company if the employee is fired, defects to a competitor, or otherwise forfeits the benefit.

From the participant's perspective, NQDC plans offer a reduced tax burden and a retirement savings bonus. This is especially valued by 澳洲幸运5官方开奖结果体彩网:highly compensated employees because qualified 401(k) plans have annual contribution limits.On the downside, the money in NQDC plans does not have the same protection as a 401(k) balance. If the company goes bankrupt, creditors can seize funds from NQDC plans.

For some companies, NQDC plans are a way to hire expensive talent without having to pay their full compensation immediately, meaning they can postpone funding the oblig⭕ations. That approach, however, can be a gamble for the employee.

Deferred Compensation vs. 401(k)

A deferred compensation plan is generally an addition to a company 401(k) plan and may be offered only toꩵ a few executives and other key employees as an incentive. Generally, those employees participate in both plans. They max out their contributions to the company 401(k) while enjoying the bonus of a deferred compensation plan.

That said, a 401(k) plan that includes a matching contribution from an employer is technically a form of deferred compensation. It's part of a regular salary that is payable only after the employee leaves the company or retires, much like a type of non-qualified deferred compensation called a "golden parachute", which is reserved for highly-compensated employees.

However, the 401(k) is a qualified plan, meaning the employer must stick to federal regul൩ations that ensure the integrity of such plans. Non-qualifying plans a🌜re less regulated.

Advantages of Deferred Compensation

Unlike 401(k)s or 澳洲幸运5官方开奖结果体彩网:individual retirem🔜💫ent accounts (IRAs), there are 🎃no contribution limits to a deferred compensation plan. An eligible employee can, for example, earmark an annual bonus as retirement savings.

The money in both of these plans can grow tax-free until it is withdrawn. (The big exception is the Roth 401(k) or Roth IRA, where contributions are taxed when they are made and no further taxes are due on withdrawals.)

The absence of contribution limits can add🌠 a great deal of value to a deferred compensation plan for a highly-paid 𒊎employee.

The plans also offer tax-deferrꦍed growth and a tax deduction for the period that the contributions are made.

There are, however, some drawbacks.

Disadvantages of Deferred Compensation

With a deferred compensation plan, you are effectively a creditor of the company, lending the company the salary you have deferred. If the company declares bankruptcy in the future, you can lose some or all of this money.

Even if the company remains solid, your money is locked up, in many cases, until retirement, meaning that you cannot access it easily.

Depending on the plan's structure, you also may find yourself with limited investment options. It may include only the company's stock, for example.

Unlike with a 401(k) plan, when funds are received from a deferred compensation plan they cannot be rolled over into an IRA account.

The Bottom Line

Though a 401(k) plan with a matching contribution is technically a type of d෴eferred compensation, most people are typically referring to the non-qualified form when they talk about deferred compensation.

Financial advisors usually suggest you only use a non-qualified deferred compensation (NQDC) plan after you've made the maximum possible contribution to your 401(k)—and only if your employer is very solid financially, because NQDC plans are not strictly regulated and your funds may not be protected in the case of company bankruptcy. Deferred compensation plans are non-qualified, meaning they don't have to follow certain federal regulations. Tread carefully.