Deferred Compensation

What Is A Deferred Compensation?

Deferred compensation is a portion of an employee’s remuneration set aside to be paid at a specified future date.

Majorly, taxes on this income plan are deferred until there is a payout.

Deferred compensation usually takes the shape of retirement plans, pension plans, and stock-option plans. They are used as a strategy used by employers to secure key employees, can be either structured or unstructured, and are especially suitable for earners in the high-income brackets.

It is instructive to note that there’s no security for funds in a deferred compensation plan, especially when the parent company files for bankruptcy. Creditors will latch on to the said funds.

Deeper Definition

A deferred compensation plan allows employees to deposit a percentage of their income in a retirement account where taxes are not charged until withdrawal. Upon doing so, the taxes can be made much less when payment is held back until retirement.

 When the employees expect to be in a lower tax bracket upon retirement than when the compensation was initially earned, it provides tax relief.

Roth 401(k)s are a deviation from this as executives who expect significant jumps in their earning power and income range are taxed in their current lower economic states.

Types include ‘qualified retirement plans’ like 401(k), 403(b), and 457 plans in which tax reductions are made once the funds are deposited, and 409(a) plans where ‘non-qualified deferred compensation plans’ are offered to executives and key employees with plans that position their employees to put more into the savings till than a regular qualified plan.

Deferred Compensation Example

A deferred compensation plan offered to employees and key executives is the supplemental executive retirement plan (SERP) that mirrors defined benefit plans by guaranteeing a set amount initially that is obtainable on request at retirement.

It is usually commonly calculated by a number of methods, including a flat dollar amount for a previously agreed number of years, a percentage of salary multiplied against the number of years at retirement, a portion of the wage regularly remitted for a certain number of years or by funding a cash value life insurance policy to pay out chosen beneficiaries in case of an untimely death.